Tax Avoidance and Corporate Investments

Mahmud Hossain (), Gerald J. Lobo () and Santanu Mitra
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Mahmud Hossain: Department of Accounting and Finance, University of West Georgia, 1601 Maple Street, Carrollton, GA 30118, USA
Gerald J. Lobo: C. T. Bauer College of Business, University of Houston, 4250 Martin Luther King Boulevard, Houston, TX 77204-6021, USA
Santanu Mitra: Mike Ilitch School of Business, Wayne State University, 2771 Woodward Avenue, Detroit, MI 48201, USA

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2022, vol. 25, issue 02, 1-53

Abstract: This study examines the association between firms’ tax avoidance and long-term investments. We find that tax avoidance firms make greater investment than nontax avoidance firms, and that the positive association between tax avoidance and investments holds both for firms that are financially constrained, and therefore ex-ante likely to underinvest, and for financially unconstrained firms that are ex-ante more likely to overinvest. Our results further show that CEO equity incentives and governance strength exert an incremental effect on investment decisions of tax avoidance firms. In additional analyses, we demonstrate that tax avoidance firms’ investments are associated with improved future firm performance especially when those firms are ex-ante more likely to underinvest. For tax avoidance firms that are ex-ante more likely to overinvest, current investments are associated with declined future firm performance. Tax avoidance firms have higher (lower) investment efficiency in terms of improved (declined) operating profitability in the post-investment period when they have lower (higher) CEO equity incentives and stronger (weaker) governance. Overall, our results shed light on efficiency in utilizing the available cash through tax avoidance in long-term investments that might create shareholder value for a group of financially constrained firms but diminish shareholder value for another group of financially unconstrained firms.

Keywords: Tax avoidance; long-term investment; CEO equity incentives; managerial entrenchment; governance; firm performance; abnormal ROA; Tobin’s q (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1142/S0219091522500138

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