Tax avoidance and over‐investment: The role of the information environment

Abstract

We investigate whether the association between tax avoidance and over‐investment is moderated by a firm's information environment. Prior research (Blaylock, 2016) finds no association between tax avoidance and over‐investment, but the study did not consider the impact of financial reporting quality (FRQ). It seems likely that FRQ is a moderating variable because Balakrishnan, Blouin, and Guay (2012) find that a firm's information environment is affected by tax planning while Biddle and Hilary (2006) find that FRQ is negatively associated with investment. We find that tax avoidance is positively associated with over‐investment when the information environment is weak, and that having a richer information environment mitigates this association. Our results are robust across multiple measures of tax avoidance and multiple proxies for the quality of the information environment. In addition, our results hold after propensity score matching, controlling for governance and the firm's internal resources, partitioning on managerial ability, and in a change analysis. These findings highlight the important role of financial information in corporate investment behavior and enhance our understanding of the link between tax avoidance and agency costs.

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“…Country control variables include MCPV and industry affiliation (INF). MCPV is measured by multiplying the stock price by the number of outstanding shares ( Abdul Wahab et al., 2017 ; Ha and Feng, 2020 ). We include INF to control for the variation in firm performance across industries.…”

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