Does Corporate Tax Avoidance Impair Earnings Informativeness?

Kubata Adrian, Lietz Gerrit, Watrin Christoph

Abstract

We investigate a previously overlooked type of non-tax cost associated with tax avoidance: the potential loss of earnings informativeness. Up-front benefits realized by corporate tax planning include positive effects on after-tax earnings and an increase in firm value. However, we argue that tax avoidance might also cloud the sight of investors on earnings and thus reduce their decision usefulness. We run tests on a large U.S. sample over the period 1999 to 2009. Results suggest tax avoidance is significantly negatively associated with earnings informativeness as measured by the Earnings Response Coefficient (ERC) derived from a standard pricing model. We control for a number of factors that have been shown to affect the ERC, e.g. growth, risk, size, and leverage (Collins and Kothari [1989]). Besides GAAP and Cash effective tax rates, we further employ a range of tax avoidance proxies (e.g. Frank, Lynch, and Rego [2009]'s DTAX measure and Wilson [2009]'s shelter probability), in order to triangulate our findings. We find consistent results, further suggesting that tax-driven transparency issues that likely affect earnings informativeness are probably not limited to particular aggressive subsets of tax avoidance.