Research

Shareholder Wealth Effects of Border Adjustment Taxation

04/24/2017 • Prof. Edward L. Maydew, Fabio B. Gaertner, Edward L. Maydew
We examine the effects of a proposed border adjustment tax on the share prices of publicly traded firms. Border adjustment refers to exempting export revenue from taxation while also disallowing deductions for the cost of imports, and has been proposed as a potential U.S. corporate tax reform. The economic effects of the border adjustment tax have proved to be highly controversial, with wide differences of opinion among experts, but little in the way of empirical evidence. To provide empirical evidence on the shareholder wealth effects of border adjustment, we examine equity market reactions on days with high attention paid to the proposed border adjustment tax. We develop a daily index of attention to the border adjustment tax using internet search volume as reflected in Google Trends. We find evidence of significant shareholder wealth effects from the proposed border adjustment tax. Specifically, firms in retail and other import-intensive industries experience significant, negative stock returns on days of high attention to the border adjustment tax. This response is mitigated in firms with foreign operations.

The Taxman Cometh: Does Tax Uncertainty Affect Corporate Cash Holdings?

March 2017 • Prof. Edward L. Maydew, Michelle Hanlon, Daniel Saavedra
We examine whether firms hold more cash in the face of tax uncertainty. Because of gray areas in the tax law and aggressive tax avoidance, the total amount of tax that a firm will pay is uncertain at the time it files its returns. The tax authorities can challenge and disallow the firm’s tax positions, demanding additional cash tax payments. We hypothesize that firms facing greater tax uncertainty hold cash to satisfy these potential future demands. We find that both domestic firms and multinational firms hold larger cash balances when subject to greater tax uncertainty. In terms of economic significance, we find that the effect of tax uncertainty on cash holdings is comparable to that of repatriation taxes. Our evidence adds to knowledge about the real effects of tax avoidance and provides a tax-based precautionary explanation for why there is such wide variation in cash holdings across firms.

Is the Market Grossed out by Gross-Ups? An Investigation of Firms that Pay Their CEOs’ Taxes

January 2017 • Jeffrey L. Hoopes, Xiaoli (Shaolee) Tian, Ryan J. Wilson
This study provides evidence on whether investors value tax gross-up provisions for executives, and how the elimination of these provisions changes executive compensation. We examine the market response to tax gross-up eliminations and find investors react favorably to the removal of these provisions, suggesting that on average, investors perceived these agreements as a bad compensation practice that destroyed firm value. Next, we examine whether firms respond to these eliminations by increasing other forms of executive compensation. We find firms eliminating tax gross-up provisions increase bonus but not salary. Broadly, we provide evidence that some features of compensation contracts are not valued by shareholders, and that the elimination of these features can lead to increased firm value.

Public Tax-Return Disclosure

December 2016 • Jeffrey L. Hoopes, Leslie Robinson, Joel Slemrod
We investigate the effect of public disclosure of information from corporate tax returns filed in Australia on consumers, investors, and the corporations themselves that were subject to disclosure. Supporters of more disclosure argue that increased transparency will improve tax compliance, while opponents argue that it will divulge sensitive information that is, in many cases, misunderstood. Our results show that large private companies are likely to experience consumer backlash and are also, perhaps as a consequence, more likely to act to avoid disclosure. We also fail to detect any material increase in tax payments, one objective of legislating the disclosure regime. Finally, we find that investors react negatively to anticipated and actual disclosure of tax information, most likely due to anticipated policy backlash than the revelation of negative tax information. These findings are important for both managers and policymakers as the trend towards increased tax disclosure continues to rise globally.

Banks as Tax Planning Intermediaries

December 2016 • Prof. Edward L. Maydew, John Gallemore, Brandon Gipper
We provide the first large-sample evidence of banks playing an important role in facilitating tax planning of their client firms. We posit that banks act as tax planning intermediaries, developing and implementing tax strategies for corporate clients and by facilitating such strategies’ spread across firms. Capturing bank-client relationships using lending contracts, we find that a client’s own tax planning is strongly associated with the average tax planning of its bank’s other clients. Further tests using new banking relationships show that clients experience meaningful reductions in their taxes when they begin a relationship with a bank whose existing clients engage in above-median tax planning. The effect is stronger when the new bank has above-median investment banking activities. Moreover, the effects are concentrated in clients with foreign income and those with greater credit risk and in relationships characterized by longer periods and larger lending facilities. Our results suggest that while banks are financial intermediaries, they also act as tax planning intermediaries, facilitating tax planning across their relationship networks.

Tax Distractions: The Effects of Temporary Tax Law on Capital Markets

December 2016 • Jeffrey L. Hoopes
This paper investigates the extent to which the expiration of a temporary tax law reduces market participants’ ability to understand corporate performance. Examining evidence from eight separate expirations of the R&D tax credit, I find that analysts’ forecast errors, abnormal bid-ask spreads, and abnormal volume increase surrounding quarterly earnings announcements for firms affected by the R&D tax credit. These increases suggest difficulties in interpreting performance that are affected by the expired R&D tax credit. The results of this study call attention to previously unexplored costs of temporary tax laws, namely, capital market confusion related to temporary tax laws.

When Does Tax Avoidance Result in Tax Uncertainty?

August 2016 • Prof. Edward L. Maydew, Michelle Hanlon, Scott Dyreng
We investigate the relation between tax avoidance and tax uncertainty, where tax uncertainty is the possibility of losing a claimed tax benefit upon challenge by a tax authority. On average, we find that tax avoiders, i.e., firms with relatively low cash tax rates, do bear significantly greater tax uncertainty than firms that have higher cash tax rates. However, we find that this relation is driven by firms with tax haven subsidiaries and high levels of R&D expense, proxies for intangible-related transfer pricing strategies. Thus, contrary to expectations, general tax avoidance (i.e., unrelated to tax havens) does not explain variation in tax uncertainty. The findings have implications for several puzzling results in the literature but also raise new questions.

Corporate Tax Behavior and Political Uncertainty: Evidence from National Elections around the World

June 2016 • Prof. Edward L. Maydew, Qingyuan Li, Richard H. Willis
We empirically investigate the effects of political uncertainty on corporate tax behavior. To identify the effects of political uncertainty, we construct a data set that tracks whether firms’ tax avoidance varies systematically around the occurrence of national elections. Our dataset includes firms exposed to 103 national elections in 30 countries. We find that corporate tax avoidance varies systematically across the election cycle, peaking in election years and declining the next year. The effect on tax avoidance is greatest for elections with greater electoral uncertainty, and for elections in countries with relatively lower quality of law, relatively weaker tax enforcement, and relatively lower book-tax conformity. The evidence suggests that firms use both conforming and nonconforming tax avoidance strategies, although the results for conforming tax avoidance are marginal.

Who Sold During the Crash of 2008-9? Evidence from Tax-Return Data on Daily Sales of Stock

April 2016 • Jeffrey L. Hoopes, Patrick Langetieg, Stefan Nagel
We examine individual stock sales from 2008 to 2009 using population tax return data. The share of sales by the top 0.1 percent of income recipients and other top income groups rose sharply following the Lehman Brothers bankruptcy and remained elevated throughout the financial crisis. Sales by top income and older age groups were relatively more responsive to increased stock market volatility. Volatility-driven sales were not concentrated in any one sector, but mutual fund sales responded more strongly to increased volatility than stock sales. Additional analysis suggests that gross sales in tax return data are informative about unobserved net sales.

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