05 Taxation

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    Institutional Blockholder Political Orientation and Tax Avoidance
    ( 2020-08-17) Li, Zining ; Plecnik, James ; Ryou, Ji Woo
    Prior literature shows that institutional investors influence the tax policies of investee firms. Our study examines the effect of Republican-oriented institutional blockholders on tax avoidance, and finds that investee-firm tax avoidance increases as the ownership by Republican-oriented institutional blockholders increases. Next, we find that Republican-oriented institutional investors are most effective in influencing investee tax avoidance when (1) investee firms' CEOs have compatible political orientations, and (2) investee firms are located in compatible political climates. Our findings add to the literature on the active role of institutional investors in firm policies and provide evidence that institutional investors' political orientation can influence investee firms' tax avoidance.
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    DOES PRIVATE COUNTRY-BY-COUNTRY REPORTING IMPROVE THE TAX AND EARNINGS INFORMATION ENVIRONMENT FOR INVESTORS?
    ( 2020-08-16) Persson, Anh ; Huang, Jing ; Jiang, John
    To better align rights to tax with underlying economic activities, many countries require multinational enterprises (MNEs) to disclose their income and economic activities to tax authorities on a country-by-country reporting (CbCR) basis. We examine whether this significant international tax transparency policy shock generates positive information externalities for the capital markets. We develop a novel approach to capture the misalignment between MNE's tax and economic activities, as perceived by the capital market, using the unexplained portion of analysts' tax forecasts error. We find that this misalignment declines after the adoptions of CbCR, supporting the effectiveness of its policy objective. We then examine the tax and earnings information environment using analysts' forecast accuracy and the information content of tax and earnings to investors. We find that CbCR helps improve both tax and earnings information environment, especially when firms have more misalignment prior to the policy change. Our findings have important policy implications for governments worldwide that are trying to assess the economic consequences of CbCR.
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    Does the Diversification of Tax Strategies Affect Tax Risk?
    ( 2020-08-15) Krieg, Kimberly
    I investigate the effect that the number of different tax strategies employed by a public company has on the relation between measures of corporate tax avoidance and measures of risk. Prior studies have generally failed to find a relation between measures of overall firm risk (such as stock return volatility) and measures of corporate tax avoidance (such as low effective tax rates). One possible reason for this empirical result is the failure to consider the role that the diversification of tax risk, through utilization of a portfolio of different tax avoidance strategies, might have on reducing tax risk and, as a result, on reducing overall firm risk. I create a broad measure of diversification based on five sources of tax benefits. Controlling for the level of tax avoidance, I regress measures of risk on diversification and an interaction term and find weak support that diversification reduces tax risk, as measured by the volatility of future cash ETRs, and mixed evidence on the effect of diversification on overall firm risk, as measured by the volatility of future monthly stock returns.
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    FASB Interpretation Number 48 (FIN 48) and Corporate Innovation
    ( 2020-08-15) Goldman, Nathan ; Lampenius, Niklas ; Radhakrishnan, Suresh ; Stenzel, Arthur ; de Almeida, Jose Elias Feres
    In this paper, we analyze the real effect of financial statement tax disclosures on corporate innovation activities. In 2007, the FASB issued FIN 48, which mandates the separate disclosure of reserves for unrecognized tax benefits (UTBs). Using patent applications as a measure of corporate innovation, we employ a difference-in-difference research design with publicly listed U.S. firms as the treatment group and privately held U.S. firms not subject to the disclosure requirements as the control group. We hypothesize and find robust evidence that following the onset of FIN 48, the number of patent applications by publicly listed firms decreased. We also provide evidence that the decrease is attributable to incremental innovation, which is more subject to the UTB disclosure requirements. Overall, our evidence provides support for the real effects of disclosures on innovation activities.
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    Income Shifting and Management Incentives
    ( 2020-08-15) Ortmann, Regina ; Schindler, Dirk
    The tax literature shows that income shifting within multinational enterprises collides with optimal incentivization of managers in subsidiaries. The different modes of income shifting have received different attention, however, and the incentive implications of internal debt shifting have not yet been investigated. We analyze the different impacts of tax—efficiently setting intercompany prices for the use of intangibles (royalties) and debt shifting on incentivization of affiliate managers. Different from most other studies, we focus on endogenous, unobservable managerial effort and the firm's optimal design of the (linear) compensation contract. For EBIT(DA) as performance measure, we find that internal debt shifting does not have a direct effect on management incentives, but has an ambiguous indirect effect via its positive effect on investment. In contrast, tax—motivated royalty payments have a clearly negative incentive effect that is fully offset, however, by an higher compensation rate. Hence, the adjustment of the compensation payment reveals the firm's aggressiveness in income shifting via intangibles. There is no confounding indirect effect from tax—motivated royalty payments because these royalty payments do not affect investment.