Firm Valuation and the Uncertainty of Future Tax Avoidance

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractThe paper studies the effect of uncertainty in tax avoidance on firm value. We first show in a clean surplus valuation model that expected tax rates interact with expectations about future profitability. This paper builds and tests a valuation framework that incorporates two outcome dimensions of corporate tax avoidance strategies: the stability and the level of expected tax rates. We develop a tax planning score that captures these two dimensions.The measure improves the prediction of future tax avoidance. We finally show that the tax planning score strengthens the effect of pre-tax earnings on firm value. Firms with effective and persistent tax planning have a stronger effect of pre-tax earnings on firm value while firms with poor tax planning or volatile effective tax rates receive a discount on their earnings.

Financial constraints and future tax outcome volatility

“…Consequently, volatile cash ETRs amplify capital providers' concern about tax aggressiveness given the uncertainty surrounding after-tax cash flows (Drake et al, 2019;Guenther et al, 2017;McGuire et al, 2013). In line with this notion, prior research highlights that investors and lenders penalize firms with volatile cash ETRs by increasing the costs of capital and decreasing firm valuation (Jacob & Schütt, 2020;Saavedra, 2018). While tax-reducing activities with uncertain outcomes help to alleviate financial constraints in the current period, they could increase a firm's refinancing risk, and thus the likelihood of financial distress in the future.…”

“…(2017) document that the volatility of cash ETRs signals future stock return volatility, whereas the level of cash ETRs does not. Jacob and Schütt (2020) find that the level and the volatility of cash ETRs are jointly related to firm value.…”

“…Interest in the volatility dimension of corporate tax planning has accelerated in recent years (Drake et al., 2019; Delis, Hasan, & Karavitis, 2020; Guenther, Matsunaga, & Williams, 2017; Neuman, 2019). Providing evidence on the determinants of tax rate volatility is critical because recent studies find that firms with volatile tax rates face significant consequences, such as higher costs of capital (Saavedra, 2018), lower firm valuation (Jacob & Schütt, 2020), more information asymmetry (Bratten, Gleason, Larocque, & Mills, 2017), less value relevant after‐tax earnings and cash flows (Drake et al., 2019), and higher audit fees (Abernathy, Finley, Rapley, & Stekelberg, 2019). Despite the heated discussion about the association between non‐tax costs and volatile tax outcomes, little evidence is available about why some firms exhibit substantially more volatile tax rates than others (Wilde & Wilson, 2018).…”

“…Nevertheless, financially constrained firms might not employ tax strategies that generate more volatile future tax rates for several reasons. First, tax reduction activities with less sustainable cash tax savings increase uncertainty about after‐tax cash flows and have adverse capital market consequences such as higher costs of capital and lower firm valuation (Drake et al., 2019; Jacob & Schütt, 2020; Saavedra, 2018). These non‐tax costs can expose firms to greater refinancing risk and increase the likelihood of financial distress in the future.…”