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. 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.

Does Tax Risk Affect Investor Valuation of Tax Avoidance?

“…A related concurrent working paper, Jacob and Schütt (2015), also examines firm value as a function of both tax avoidance and the volatility of tax avoidance. However, our study differs from theirs in a number of ways.…”

Profit shifting and tax‐rate uncertainty

“…In turn, the frequency of changes and volatility in corporate tax rates increase uncertainty for an MNE. Edmiston (), Edmiston, Mudd, and Valev (), and Jacob and Schütt (), working in a tax‐avoidance framework, utilize the standard deviation of effective tax rates. In each case, higher tax‐rate volatility is associated with increased risk of inaccurately predicting profit‐shifting benefits, and such uncertainty is clearly costly for the MNE.…”

When Do Firms Highlight Their Effective Tax Rate?

“…We identify three unfavourable conditions: volatile ETRs, increasing ETRs, and ETRs well above the industry average. Jacob and Schütt (2020) . In line with this notion, Li (2019) finds that disclosures in the MD&A section are informative for shareholders even when the information is repeated in other parts of the annual report.…”