Investor Valuation of Tax Avoidance Through Uncertain Tax Positions

This paper examines equity investor valuation of tax avoidance achieved through uncertain tax positions. New financial reporting standards require firms to separately disclose their contingent liabilities for tax positions that may be disallowed upon tax return audit. This disclosure provides investors with information about the magnitude of firms’ tax avoidance activity through uncertain tax positions, or uncertain tax avoidance. I find evidence consistent with investors positively valuing uncertain tax avoidance, with a greater positive valuation placed on uncertain tax avoidance that gives rise to permanent tax savings relative to temporary tax savings. This positive valuation suggests that tax-related contingent liabilities are viewed very differently from other liabilities. My findings are consistent with investors interpreting managers’ prior and current period uncertain tax avoidance activity as an indicator of future uncertain tax avoidance activity where the economic benefit of avoidance (i.e., cash tax savings) is expected to be retained. Cross-sectional tests provide some evidence that uncertain tax avoidance is positively valued only in well-governed firms, consistent with investors believing the economic benefit of uncertain tax avoidance does not fully accrue to shareholders when governance mechanisms are weak.