What Does Tax Aggressiveness Signal? Evidence from Stock Price Reactions to News About Tax Aggressiveness

We study the stock price reaction to news about tax aggressiveness. We find that, on average, a company’s stock price declines when there is news about its involvement in tax shelters. The stock price decline is smaller for companies with relatively high effective tax rates, possibly because news about tax aggressiveness is more favorably viewed for those firms where public information would suggest otherwise. The stock price decline is also smaller for firms that have good governance which is consistent with the idea that for these firms the news is less likely to trigger concern about insiders’ aggressiveness toward the investors themselves. Indeed, our results suggest that for wellgoverned firms with especially high effective tax rates, news that they have been involved in a tax shelter is received favorably by the market. The reaction is more negative for firms in the retail sector, suggesting that part of the reaction may be a consumer/taxpayer backlash. We also explore the stock price reaction to reports of effective tax rate calculations released by Citizens for Tax Justice. We hypothesize that these reports signal tax aggressiveness without the implications for tax penalties or illegal behavior that tax shelter news carries, and therefore any market reaction represents a pure reputation effect. We find no statistically significant stock price reaction to the reports, suggesting that the negative reaction to tax shelter news is not predominantly a reputation effect. All in all, our analysis suggests that tax shelter news is viewed as a negative event by the market, although the stock price reaction is much smaller than the reaction to major accounting mishaps. We are grateful to Estelle Dauchy and Kyle Peterson for able and tireless research assistance. We appreciate comments on earlier drafts from Dhammika Dharmapala, Doug Shackelford, and Terry Shevlin.