Institutional Quality, Tax Avoidance, and Analysts’ Forecast: International Evidence

Research Question: This study examines the joint-effect of tax avoidance and institutional quality on analysts forecast. Motivation: The aspects of tax are important in the valuation by financial analysts in the capital markets, but the extent to which the analysts incorporate tax avoidance in their forecasts is uncertain. The complexity associated with tax avoidance may lead to more efforts for appropriate forecast, but such complexity may also reduce the ability of the analysts in forecasting. Further, when institutional theory is considered, the strength of country-level institutional environment may influence the role of the analysts in factoring tax avoidance in their forecast. Idea: This study hypothesized that tax avoidance is associated with analyst forecast, and the strength of institutional quality jointly affects the association between tax avoidance and analyst forecast. Data: The dataset consists of 22,690 firm-year observations from 36 countries over the period 2007-2016. Data were gathered from Institutional Brokers' Estimate System I/B/E/S, Thomson Reuters Fundamentals, the World Governance Indicators, OSIRIS and ownership data reported in La Porta et al. (2006). Method/Tools: The regression models employ two measures of analyst forecasts as the dependent variables; forecast dispersion and accuracy. The test variables are tax avoidance that is proxied by firms’ effective tax rate, institutional quality that is an index from Kaufmann et al. (2009) to proxy for country-level institutional environment, and the interaction between tax avoidance and institutional quality. Findings: Findings indicate that high tax avoidance is associated with high forecast dispersion but more accurate forecast. There are evidence that the effect of tax avoidance on properties of analyst forecast is weakened for firms in high institutional quality countries. The results are robust even after employing the two-stage least square regression to address endogeneity issue, and the weighted least square in overcoming issue of differences in sample size between countries. Contributions: The findings corroborate evidence on tax avoidance and analyst forecast, and enrich the international accounting literature. This study provides insights to policy makers on the role of institutional quality in reducing information asymmetry, specifically on tax and forecast activities