Professional Documents
Culture Documents
1. Introduction
This study investigates whether rms and their top executives bear reputational costs from
engaging in aggressive tax avoidance activities. At least two decades of empirical tax
research has shown that rms engage in a wide range of strategies for tax avoidance pur-
poses.1 Recent studies suggest that for many rms, tax avoidance appears to be highly
eective at reducing the rms tax payments and increasing their after-tax earnings. For
example, Dyreng, Hanlon, and Maydew (2008) nd that more than a quarter of publicly
traded U.S. rms are able to reduce their taxes to less than 20 percent of their pre-tax
earnings, and are able to sustain such low rates of taxation over periods as long as ten
years. Tax avoidance strategies are abundant and include a wide variety of activities such
as shifting income into tax havens (Dyreng and Lindsey 2009), using complex hybrid secu-
rities (Engel, Erickson, and Maydew 1999), and engaging in other tax shelters (Wilson
2009).
While the evidence indicates there is wide variation in tax avoidance across rms,
the extant literature has a dicult time explaining this variation. What is puzzling is
not that some rms engage in tax avoidance, but rather why some rms engage in it
enthusiastically while others appear to shun it. For example, while showing that some
rms engage in substantial tax avoidance, Dyreng et al. (2008) also nd that approxi-
mately one-fourth of rms pay taxes in excess of 35 percent of their pre-tax income
over a ten-year period. Given a U.S. federal corporate tax rate of 35 percent, these
rms appear to be engaging in little or no sustainable tax avoidance. The question of
why so many rms do not avail themselves of tax avoidance opportunities has been
coined the under-sheltering puzzle (Desai and Dharmapala 2006; Hanlon and Heitz-
man 2010; Weisbach 2002).
* Accepted by Steve Salterio. The authors would like to thank Kathleen Andries, Darren Bernard, Jenny
Brown, Nicole Cade, Charles Christian, Lisa De Simone, Katherine Drake, Don Goldman, Susan Gyeszly,
Michelle Hanlon, Bradford Hepfer, Je Hoopes, Becky Lester, Kevin Markle, Zoe-Vonna Palmrose, Phil
Quinn, Steven Savoy, Terry Shevlin, Michelle Shimek, Stephanie Sikes (Oxford discussant), Bridget Stom-
berg, Laura Wellman, Brady Williams, Ryan Wilson, participants at the 2012 Oxford University Centre
for Business Taxation annual conference, Vienna University of Economics and Business, and reading
groups at Arizona State, Iowa, MIT, and University of Texas-Austin for helpful comments. They espe-
cially thank Michelle Hanlon, Joel Slemrod, and Ryan Wilson for sharing tax shelter data and Bob Bo-
wen, Andy Call, and Shiva Rajgopal for sharing Fortune Magazine reputation data. John Gallemore
gratefully acknowledges the nancial support of the Deloitte Foundation.
1. For reviews of the literature on tax avoidance, see Hanlon, and Heitzman (2010), Maydew (2001), and
Shackelford and Shevlin (2001).
Contemporary Accounting Research Vol. 31 No. 4 (Winter 2014) pp. 11031133 CAAA
doi:10.1111/1911-3846.12055
1104 Contemporary Accounting Research
Reputational costs are often posited as an important factor that limits tax avoidance
activities, particularly the most aggressive tax strategies.2 For example, the Commissioner
of the Internal Revenue Service (IRS) asserts that aggressive tax strategies can pose a sig-
nicant risk to corporate reputations and the general public has little tolerance for
overly aggressive tax planning (Shulman 2009). However, empirical evidence on the repu-
tational costs of tax avoidance is scarce. The most compelling evidence to date is Hanlon
and Slemrod (2009) and Graham, Hanlon, Shevlin, and Shro (2012). Hanlon and Slem-
rod (2009) examine the stock price responses of rms accused of engaging in tax shelters.
They nd evidence that rms suer stock price declines following public revelation of tax
shelter behavior. They are careful to acknowledge that there are many possible determi-
nants of the negative returns, of which reputational costs are only one. With the exception
of some tests on retail rms, they leave extensive testing of reputational costs for future
research. Graham et al. (2012) survey tax executives and nd that more than half agree
that potential harm to their rms reputation is an important factor in deciding whether
or not to implement a tax planning strategy. This evidence is consistent with managers
perceiving that aggressive tax avoidance will subject them or their rms to reputational
costs.
Beyond this important initial evidence, we know very little about the reputational
costs of tax shelters. In particular, we do not know if rms that are publicly scrutinized
for having engaged in tax shelters actually bear reputational costs, as might have been
feared ex ante. In their review of tax research, Hanlon and Heitzman (2010) call for
research on the under-sheltering puzzle, specically posing the following questions: Why
do some corporations avoid more tax than others? How do investors, creditors, and con-
sumers perceive corporate tax avoidance?. . . These are interesting questions worthy of
study (137, 146). This study answers the call for research, focusing on the extent to which
tax sheltering results in reputational costs.
We analyze a sample of rms identied in prior studies as engaging in aggressive tax
shelters. Our study combines the samples of several prior studies of tax shelter behavior;
namely, Graham and Tucker (2006), Hanlon and Slemrod (2009), and Wilson (2009).
After imposing data requirements, our sample constitutes 118 rms revealed during the
period 1995 to 2005 as having engaged in tax shelters. To our knowledge, this is the larg-
est sample of publicly identied corporate tax shelters analyzed to date.
We maintain the assumption that managers act rationally in considering costs and
benets of a tax strategy for the rm. When the managers decide to engage in tax avoid-
ance, they weigh the expected benets of tax avoidance against the expected costs and will
not engage in tax avoidance unless the net benets are positive in an expected value sense.
Hence, for our sample of tax shelter users, our assumption is that managers expected the
tax shelters to yield positive net benets. However, we distinguish between the ex post cost
of getting caught and the ex ante decision to engage in tax avoidance. While the probabil-
ity of bearing reputational costs may be low ex ante, those costs will be realized ex post
for rms subject to scrutiny. Thus, a manager may rationally engage in tax sheltering even
though doing so places the rm at risk of bearing costs if it is later challenged; our objec-
tive is to assess those potential ex post reputational costs.
Reputation is a multifaceted construct associated with several parties, including the
rm and its management, as well as shareholders, customers, and tax authorities. We
begin by examining the reputational eects of tax sheltering exerted by shareholders. To
provide some assurance that the sample and research design have sucient power, we
replicate Hanlon and Slemrod (2009) using our sample and design to test for capital
2. We dene reputation as a general perception of the rm by all interested stakeholders and further discuss
this concept in section 2.
market reactions to tax shelter revelations. In the short window surrounding the revela-
tion date, we nd that the stocks publicly revealed to have tax shelters exhibit signi-
cantly negative abnormal returns, consistent with the ndings in Hanlon and Slemrod
(2009). We then expand the event period to 30 days past the revelation date to test
whether the short-window eects on stock price are permanent or temporary. We nd
evidence that, although the immediate stock price response around the tax shelter is nega-
tive, in the days that follow, the stock price systematically reverses back to its pre-event
levels. Thus, we conrm that the Hanlon and Slemrod (2009) short-window eect on
stock price is a robust result and at the same time, we also nd that it is a temporary
eect that reverses within 30 days.3
Next, we examine the potential reputational eects on the rms managers, specically
those related to their employment. We do not nd evidence of increased chief executive
ocer (CEO), chief nancial ocer (CFO), or auditor turnover in the three years follow-
ing tax shelter revelation relative to the turnover rates for matched control rms. Next, we
assess whether customers exert a reputational cost on shelter rms. We nd no dierential
change in sales, sales growth, or advertising expense for revealed shelter rms relative to
that of control rms. We also examine how the revelation of a tax shelter inuences the
public media reputation of a rm, as measured by the Fortune magazine list for Most
Admired Companies, following Bowen, Call, and Rajgopal (2010). We nd no evidence
that being caught in a tax shelter lowers the likelihood of making the Fortune list relative
to the matched control sample.
Firms also face potential reputational consequences with the tax authorities. When
the IRS learns that a rm has engaged in what it considers a tax shelter, its policy
allows it to expand the scope of information that it requests from the rm, which can
lead to the discovery of other aggressive tax avoidance. Accordingly, we examine
whether rms accused of engaging in tax shelters become more conservative in the
future regarding their tax avoidance, perhaps as a result of increased IRS scrutiny. If
they do, we would expect to observe the eective tax rate (ETR) of tax shelter rms to
increase following scrutiny of their activities. The data, however, show that the ETR of
tax shelter rms remains approximately the same before and after discovery, and this is
true regardless of whether ETRs are measured on a generally accepted accounting prin-
ciples (GAAP) basis or on a cash basis. These results suggest that rms identied as
tax shelter users may not suer signicant reputational costs even at the hands of the
tax authorities.
In summary, across a battery of tests, we do not observe a reputational eect of tax
sheltering. We are careful to note, however, that such an eect may indeed exist; but we
are simply unable to nd it empirically in our tests, perhaps because shelter rms are
peculiar or because we have a small sample and/or low power. For example, it is possi-
ble that rms expecting nonzero reputational costs ex ante avoid tax shelter use com-
pletely and that only rms that are immune to reputational concerns engage in tax
shelters. While we cannot rule out this possibility completely, it appears unlikely given
the wide variety of rms we observe engaging in tax shelters.4 Moreover, in logistic
regressions of tax shelter usage on proxies for reputation and other factors known to be
associated with tax shelter usage (Wilson 2009), we nd no evidence that reputation sig-
nicantly inuences the likelihood of tax shelter participation. In summary, the absence
of ex post reputational costs and the insignicance of reputation as a determinant of tax
3. By comparison, prior research shows that the stock price declines associated with corporate malfeasance are
permanent. For example, Hennes et al. (2008) show that the stock prices decline by nearly 30 percent
following discovery of nancial irregularities and stay at reduced levels.
4. For example, our sample of shelter users contains rms from 15 of the 17 industries in the Fama-French 17
industry classication and has total assets ranging from $13 million to $1.3 billion.
shelter use suggest that reputational costs are not likely to be responsible for the signi-
cant variation in tax sheltering. Thus, it appears that under-sheltering is more of a puz-
zle than ever.5
2. Prior literature and research question
Prior literature on tax avoidance and tax shelters
There is a vast and growing empirical literature on tax avoidance, dating back at least as
far as Scholes, Wilson, and Wolfson (1990) and continuing to the present day, that pro-
vides ample evidence that tax avoidance is pervasive and adaptable. Research has shown
that rms engage in all manner of tax avoidance strategies, ranging from simple strategies
like holding tax-exempt municipal bonds, to complex strategies such as debtequity hybrid
securities (Engel et al. 1999), cross-border avoidance strategies (Dyreng and Lindsey
2009), intangible holding companies (Dyreng, Lindsey, and Thornock 2013), and corpo-
rate-owned life insurance (COLI) tax shelters (Brown 2011).
While prior research indicates that some rms do not actively engage in tax avoidance
(Dyreng et al. 2008), the forces that are curtailing more widespread tax avoidance are not
well understood. On average, it is reasonable to assume that rms are engaging in the
optimal amount of tax avoidance. A maintained assumption in the literature, and in this
paper, is that the presence of costs of tax avoidance at some point outweigh the benets.
However, such costs have been dicult to identify.6 The lack of tax avoidance more gen-
erally, especially in nonregulated settings and settings with no nancial reporting trade-o,
has been dubbed the under-sheltering puzzle. Essentially, the question is: what is hold-
ing those rms back from taking advantage of known tax avoidance opportunities being
used by other rms?
Reputational costs are often conjectured to be an important factor constraining tax
avoidance, particularly the more aggressive forms of tax avoidance. COLI shelters are a
useful example of a tax avoidance strategy that many viewed as particularly aggressive
and that resulted in adverse scrutiny for rms that engaged in them. The COLI shelter
involved rms taking out life insurance policies on their rank-and-le employees and
then receiving the death benets if the employee died (see Brown [2010] for a more
detailed description). The COLI shelter was the subject of unattering coverage in the
media, including the Wall Street Journal, which identied the companies that engaged
in COLI alongside pictures of their actual deceased employees (Schultz and Francis
2002).
As noted in Hanlon and Slemrod (2009), there is anecdotal evidence that some rms
apply a Wall Street Journal test to their tax avoidance activities, whereby they forgo
activities that would look unsavory if they were linked to the rm on the front page of the
Wall Street Journal. There is also anecdotal evidence that companies want to be perceived
as being good corporate citizens that pay their fair share of taxes, although evidence on
this is mixed (Davis, Guenther, Krull, and Williams 2013; Watson 2011). General Electric,
for example, has been criticized by the New York Times for paying no taxes to the U.S.
government in 2011 despite being one of the largest companies in the world by earnings
5. We test the robustness of our results using two dierent matching techniques (i.e., a propensity score
matched control sample and an industry, size, and eective tax rate matched control sample), multiyear
periods (i.e., one, two, and three years following tax shelter revelation), and subsamples of rms for which
the potential reputational eect of tax shelter involvement is likely to be higher. Throughout all of these dif-
ferent specications, we do not nd signicant reputational costs from tax avoidance.
6. The costs identied are nancial reporting costs and regulatory costs, which apply to a subset of tax avoid-
ance strategies and a subset of rms, respectively. See Frank, Lynch, and Rego (2009) and Badertscher, Phi-
lips, Pincus, and Rego (2009) for examples of nancial reporting costs of tax avoidance and Mills, Nutter,
and Schwab (2013) for an example of the regulatory costs of tax avoidance .
and by market capitalization.7 GE immediately responded by pointing out its other contri-
butions to society, such as being a major employer and exporter, its prior tax payments,
as well as tallying up a broader measure of its tax burden including payroll, property, and
sales taxes paid.8
These examples are consistent with the conjecture that rms perceive reputational
costs from aggressive tax avoidance, especially when subjected to media scrutiny. To date,
however, there is little in the way of empirical evidence on the validity of that claim. The
closest evidence on the reputational eects of tax shelters is provided by Hanlon and
Slemrod (2009), who examine the change in rms market values following public revela-
tion that the rms engaged in tax sheltering, and by Graham et al. (2012), who survey tax
executives in regard to their tax planning activities. Hanlon and Slemrod (2009) nd that
when tax shelter participation is revealed in the news media, the tax shelter rms suer a
decline in market value. Graham et al. (2012) survey tax executives and nd that nearly
70 percent respond that potential harm to their rms reputation is very important or
important when deciding what tax planning strategies to implement. Moreover,
responding to a question about tax disclosures, approximately half of executives surveyed
responded that risk of adverse media attention was very important or important in reduc-
ing their rms willingness to be tax aggressive.
Other research examines the role of political costs in determining eective tax rates,
where political costs can be viewed as a type of reputational cost or at least related to rep-
utational costs. Zimmerman (1983) hypothesizes that accounting choices are often driven
by political costs, such as taxation, and nds that large rms have higher eective taxes,
which he asserts are a function of the higher political costs faced by these rms. Mills
et al. (2013) examine the inuence of political costs on the tax avoidance in a sample of
federal contractors. They nd that federal contractors that are highly sensitive to political
costs have higher eective tax rates, consistent with political costs driving the tax strategy
of federal contractors.
of rms charged with fraud have higher rates of turnover. Finally, Srinivasan (2005) nds
that outside directors face labor market penalties following accounting restatements but
not penalties through regulatory actions or litigation.
In sum, there is evidence of signicant reputational costs accruing to both rms and
managers in a range of nontax settings. This evidence suggests that it is reasonable to
expect that tax avoidance can be accompanied by adverse reputational costs if it is discov-
ered and subject to outside scrutiny. However, some evidence suggests the opposite is the
case, in which managers go unpunished following instances of inappropriate behavior.
Moreover, tax avoidance may be viewed in a completely dierent light than other corpo-
rate misdeeds because of the positive cash ow eects of such activity.
9. Other researchers (e.g., Lisowsky, Robinson, and Schmidt 2012) have obtained larger samples of tax shel-
ter transactions using condential IRS data. Although that sample is useful for many research questions,
the tax shelters in those studies are unobservable to the public and thus would not be suitable for tests of
reputational penalties exerted by outside stakeholders.
10. Since this study is conducted at the rm-year level, if there is more than one tax shelter revelation in a
year, we count that as one observation.
11. We begin our sample period in 1993 because SFAS 109 changed the rules regarding the nancial reporting
of taxes, and we want to maintain similar accounting treatment of income taxes for all our observations.
12. Both incidents involved transfer pricing, which can be considered an aggressive form of tax planning.
However, these observations are likely to be quite dierent from the other tax shelters, and hence we
remove them from the sample.
13. This time clustering results because the Tax Notes article identifying COLI users was published in 1995.
TABLE 1
Tax shelter sample
Year Revelations
1995 48
1996 7
1997 8
1998 2
1999 4
2000 4
2001 2
2002 18
2003 15
2004 9
2005 1
Notes:
a
From Graham and Tucker (2006), Hanlon and Slemrod (2009), and Wilson (2009).
b
From September 25, 1995, Tax Notes article (Sheppard 1995).
c
Both incidents involved transfer pricing rather than tax sheltering.
in the year before tax shelter revelation.14,15 We employ nancial statement data from
COMPUSTAT and executive turnover data from ExecuComp from 1994 to 2011,
although the sample using the Fortune reputation lists concludes in 2010.16 Table 2 con-
tains the descriptive statistics (panel A) and correlations (panel B) for revealed shelter
14. We require that potential control rms have data for each analysis. We require that control rms have a mini-
mum of ve years of data for the one-year regressions (CEO and CFO turnover, sales and ad expense, For-
tune reputation lists). We make no such requirement of treatment rms. Thus in the one-year regressions,
there is not necessarily a one-to-one mapping of rm-years between the treatment and control groups.
15. For matching purposes in our ex post tests, we employ the Fama-French 17 industry classication, which
can be found on Ken Frenchs website: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/
16. To maximize the sample, we follow Dyreng and Lindsey (2009, 1296) and set the following variables to
zero if missing: advertising expense, research and development expense, tax loss carryforwards, intangible
assets, special items, and long-term debt. We also use their methodology to correct for errors in foreign
tax expense, foreign pre-tax income, pre-tax domestic income, total pre-tax income, federal current tax
expense, and worldwide current tax expense.
rms and their matched control rms. The variables in this table are measured in the rst
year in which the tax shelter was subject to public scrutiny. The statistics in panel A sug-
gest that shelter rms are large, with mean (median) total assets of $10.3 billion ($10.0 bil-
lion). The variation in rm attributes in panel A is consistent with the notion that tax
shelters are used by a wide variety of rms.17
In (1), REPUTATIONAL COST is one of several proxies for rm and manager repu-
tational costs, measured in year t for a given rm i. CAUGHTFIRM is an indicator vari-
able equal to one for rms that were revealed to have been in a tax shelter, and zero for
the control rms. CAUGHTYEAR is an indicator variable set equal to one, for both treat-
ment and control rms, in the year it was revealed the treatment rm had a tax shelter
and zero otherwise. The variable of interest is the interaction of CAUGHTFIRM and
CAUGHTYEAR, which reects the reputational cost in the year the tax shelter is revealed,
relative to the rms matched control in the same year.
The dierence-in-dierences approach oers several advantages. First, it helps us to
isolate the eect of being caught engaging in a tax shelter, separate from the eects of
having the characteristics of a tax shelter user. Second, by evaluating dierences
between the revealed shelter rms and the matched control rms, we account for unob-
served changes over time, such as changes in competitive and macroeconomic forces,
which can confound interrupted time-series tests. The set of control variables diers
depending on the specic reputational cost being examined. All variables are dened in
the Appendix. In all analyses that follow (unless otherwise noted), we account for resid-
ual correlation by clustering the standard errors at the rm level, and all continuous
variables are winsorized at the 1 percent and 99 percent levels within each group (treat-
ment and control).18
17. Three other points regarding the sample are noteworthy. First, tests of dierences between the treatment
and matched control rms suggest that they are similar for many of the variables we consider. Second,
although we have data for tax shelter revelations for 118 rms, we were able to obtain the actual years the
rm was engaged in the shelter for only 24 of these rms. Most shelter revelations do not contain the
years for which the rm was actively engaged in the tax shelter. Thus, we rely on the tax shelter usage data
from Graham and Tucker (2006) and Wilson (2009), which constitutes only a small portion of our sample.
From these limited observations, we nd that the average time between the rms engagement in the tax
shelter and its revelation is approximately three to four years, which roughly corresponds to the IRS audit
cycle. Finally, there are ten rms that are repeat oenders and for these rms we include only the rst
instance of tax shelter revelation in the sample.
18. We do not include year xed eects because CAUGHTYEAR will absorb time-specic dierences in the
year the tax shelter is revealed. In untabulated tests, we repeat the analysis including year xed eects and
nd similar inferences as in the main tests.
Descriptive statistics
Reputational variables N Mean Std. dev. Median Mean Std. dev. Median
Control variables N Mean Std. dev. Median Mean Std. dev. Median
Contemporary Accounting Research
Control variables N Mean Std. dev. Median Mean Std. dev. Median
1 AD EXPENSE 0.43 0.21 0.06 0.03 0.09 0.05 0.19 0.00 0.16 0.03 0.27 0.19
2 DAD EXPENSE 0.49 0.10 0.10 0.21 0.01 0.01 0.09 0.03 0.12 0.01 0.13 0.00
3 SALES 0.28 0.11 0.56 0.08 0.01 0.03 0.11 0.11 0.08 0.02 0.08 0.09
4 DSALES 0.06 0.20 0.61 0.04 0.03 0.10 0.06 0.05 0.14 0.10 0.09 0.03
5 CEO TURNOVER 0.06 0.16 0.10 0.01 0.05 0.01 0.03 0.09 0.05 0.06 0.09 0.00
6 ADMIRED 0.00 0.03 0.03 0.04 0.05 0.01 0.06 0.24 0.01 0.02 0.17 0.13
7 ABNORMAL RETURN 0.06 0.00 0.04 0.07 0.02 0.01 0.05 0.06 0.11 0.07 0.04 0.04
8 BTD 0.16 0.00 0.15 0.04 0.01 0.09 0.07 0.05 025 0.05 0.07 0.00
9 CEO RETIRE 0.12 0.01 0.08 0.07 0.09 0.24 0.08 0.01 0.04 0.01 0.20 0.12
10 DISCRETIONARY ACCRUALS 0.07 0.06 0.04 0.03 0.02 0.00 0.16 0.17 0.06 0.09 0.01 0.02
11 EXTRAORDINARY ITEMS 0.04 0.03 0.09 0.03 0.11 0.00 0.00 0.10 0.01 0.04 0.06 0.11
12 FOREIGN INCOME 0.12 0.10 0.22 0.20 0.02 0.09 0.03 0.13 0.15 0.05 0.15 0.55
13 FOREIGN INCOME DUMMY 0.11 0.07 0.23 0.14 0.00 0.13 0.06 0.03 0.12 0.04 0.14 0.82
14 INTANGIBLE ASSETS 0.14 0.05 0.06 0.04 0.03 0.02 0.00 0.04 0.01 0.05 0.06 0.25 0.27
15 LEVERAGE 0.01 0.05 0.02 0.03 0.14 0.07 0.02 0.10 0.09 0.13 0.15 0.16 0.14
16 MTB 0.17 0.10 0.06 0.07 0.03 0.12 0.15 0.10 0.02 0.12 0.02 0.36 0.32
17 DNET OPERATING LOSSES 0.08 0.11 0.04 0.02 0.28 0.17 0.04 0.09 0.02 0.05 0.05 0.11 0.04
18 NOL DUMMY 0.05 0.06 0.10 0.06 0.13 0.11 0.07 0.07 0.06 0.02 0.10 0.08 0.18
19 PPE 0.04 0.01 0.35 0.14 0.08 0.02 0.14 0.12 0.09 0.06 0.19 0.04 0.04
20 DPPE 0.06 0.14 0.22 0.49 0.01 0.11 0.12 0.18 0.10 0.04 0.01 0.10 0.06
21 R&D EXPENSE 0.05 0.06 0.19 0.14 0.02 0.02 0.02 0.08 0.03 0.14 0.04 0.52 0.51
22 ROA 0.18 0.06 0.43 0.35 0.14 0.08 0.02 0.28 0.06 0.07 0.15 0.44 0.29
23 SENSITIVE INDUSTRIES 0.15 0.15 0.13 0.08 0.05 0.05 0.05 0.01 0.06 0.09 0.01 0.29 0.31
The Reputational Costs of Tax Avoidance
24 SIZE 0.04 0.07 0.46 0.28 0.00 0.16 0.01 0.04 0.07 0.03 0.09 0.07 0.11
25 SPECIAL 0.06 0.07 0.03 0.07 0.02 0.09 0.03 0.19 0.05 0.31 0.03 0.06 0.03
Variable 14 15 16 17 18 19 20 21 22 23 24 25
1 AD EXPENSE 0.13 0.04 0.20 0.11 0.01 0.02 0.07 0.10 0.12 0.06 0.13 0.08
2 DAD EXPENSE 0.05 0.07 0.10 0.18 0.01 0.05 0.07 0.15 0.02 0.10 0.03 0.11
3 SALES 0.05 0.04 0.02 0.05 0.06 0.18 0.15 0.04 0.22 0.02 0.40 0.01
4 DSALES 0.05 0.01 0.13 0.15 0.05 0.02 0.39 0.16 0.17 0.01 0.24 0.04
5 CEO TURNOVER 0.04 0.16 0.04 0.25 0.13 0.06 0.03 0.04 0.16 0.05 0.02 0.12
6 ADMIRED 0.02 0.07 0.21 0.05 0.11 0.01 0.08 0.04 0.08 0.05 0.19 0.05
7 ABNORMAL RETURN 0.05 0.01 0.11 0.04 0.04 0.15 0.08 0.01 0.10 0.01 0.00 0.06
8 BTD 0.05 0.07 0.20 0.04 0.14 0.07 0.12 0.10 0.44 0.02 0.04 0.49
Notes:
This table presents descriptive statistics for the variables used in our analyses, all of which are measured in the tax shelter revelation year. Panel A
presents descriptive statistics for the sample and panel B presents the Pearson and Spearman correlations. The sample is composed of all treatment
rms and their matched control rms with nonmissing data in the initial tax shelter revelation year. All variables are dened in the Appendix. All
continuous variables are winsorized at the 1st and 99th percentiles. Dierences in means between the treatment rms and matched control rms are
indicated in panel A, with denoting a signicant mean dierence at the 5 percent level.
The Reputational Costs of Tax Avoidance 1115
TABLE 3
Capital market reaction to tax shelter revelationreplication of Hanlon and Slemrod (2009)
(1)
Variables ABNORMAL RETURN
CAUGHTFIRM 0.0003
(1.351)
CAUGHTPERIOD 0.0001
(0.083)
CAUGHTFIRM * CAUGHTPERIOD 0.0025*
(2.030)
CONSTANT 0.0002
(0.959)
Observations 25,810
Adjusted R2 0.000
Estimated three-day CAR 0.75%
Notes:
This table presents the results of OLS regression of abnormal daily returns on an indicator for the
date on which a rm is revealed to have a tax shelter, an indicator for the rm, and the
interaction of these two variables. The sample consists of treatment rms and control rms
matched on industry and size, and includes the three-day period centered around the tax
shelter revelation and the sixty days before and after this period. The dependent variable is the
abnormal daily return, calculated as the rms raw daily return minus the daily return for the
CRSP value-weighted index. CAUGHTFIRM is an indicator variable equal to one if the rm
has ever been revealed as having a tax shelter (i.e., a treatment rm), and zero otherwise.
CAUGHTPERIOD is an indicator variable equal to one, for both the treatment and matched
control rm, in the three-day period surrounding the rst trading day subsequent to the day in
which it was revealed that the treatment rm had engaged in a tax shelter, and zero for all
other days. The estimated three-day CAR is calculated by multiplying the coecient on the
interaction term CAUGHTYEAR * CAUGHTPERIOD by 3. Daily abnormal returns higher
than 25 percent or lower than 25 percent are winsorized. Coecients are presented with
t-statistics based on standard errors clustered by rm and trading day in parentheses. *
represents signicance levels of 5 percent all for two-tailed tests.
0.0%
Mean CAR
Notes:
This gure plots the mean cumulative abnormal return for shelter rms in event time around the
rst revelation that the rm has engaged in a tax shelter. Cumulative abnormal returns are cal-
culated by taking the dierence between the rms stock return and the value-weighted CRSP
return each day and summing these dierences starting on day 5. The y-axis denotes the
cumulative abnormal return. The x-axis denotes the day through which the cumulative abnor-
mal return was calculated, with day 0 being the day the shelter was revealed.
and Slemrod (2009). Figure 1 presents the average cumulative abnormal returns for the
tax shelter rms, which shows the same eect visually.
Under the notion that reputation is a multiperiod construct, we next evaluate whether
short-window eects on stock price are temporary or permanent. Prior research has shown
permanent stock price declines following discoveries of corporate malfeasance (e.g.,
Hennes et al. 2008). To test the permanence of the stock price decline, we plot in Figure 1
the cumulative abnormal return over a 36-day window, with the accumulation starting ve
days before tax shelter revelation and ending 30 days after revelation. The gure shows
that when the event window is extended to 30 days following the tax shelter revelation,
the abnormal returns revert to eectively zero. This evidence is consistent with a tempo-
rary response by investors.
19. We are interested in CEO and CFO turnover because these are the most important positions in the rm.
Moreover, executives set the tone at the top and are commonly held accountable for the decisions made
under their watch, regardless of whether they directly inuenced the decision. Ideally, we would also exam-
ine turnover in tax directors, who also play a critical role in the tax decisions of the rm (Armstrong et al.
2012). The tax director is the individual most likely to suer reputational costs from aggressive tax avoid-
ance. However, data on tax director turnover is not publicly available.
In the implementation of (1) for executive turnover, the set of control variables are those
that previous research has shown to inuence CEO or CFO turnover (e.g., Engel, Hayes,
and Wang 2003; Gilson 1989; Hennes, Leone, and Miller 2008; Menon and Williams
2008). The control set includes SIZE, ABNORMAL RETURN, ROA, LEV, and CEO
RETIRE, as dened in the Appendix.20 All control variables in this test are measured in
the year prior to the tax shelter revelation.
Figure 2 plots the frequency of CEO and CFO turnover in event time around the year
in which the tax shelter was revealed (year 0). For each event year, we present the number
of CEOs (panel A) or CFOs (panel B) that left the company. The darkly shaded columns
measure the turnover frequency for revealed shelter rms and the lightly shaded columns
measure the turnover frequency for matched control rms. For both CEOs and CFOs,
visual inspection shows very little dierence in turnover frequency between the revealed
tax shelter rms and the control rms before or after the tax shelter revelation (i.e., in
years 0, 1, and 2). In fact, Figure 2 reveals that only one CFO in our sample turned over
in year 0, which is the smallest amount of CFO turnover in any year examined, and far
less than the amount of CFO turnover for the control rms in the same year. With only a
single instance of CFO turnover in the year of tax shelter revalation, multivariate tests on
CFO turnover would not be very meaningful. Therefore, our multivariate analyses of exec-
utive turnover focuses on CEOs.
Table 4 presents the results of logistic regressions estimating (1), in which the depen-
dent variable is an indicator variable equal to one if the rm experienced CEO turnover
that year and zero otherwise.21 In column (1), there is no evidence that revealed shelter
rms experience a signicantly higher likelihood of CEO turnover than a matched control
sample. In column (2), we nd the same lack of signicant increase in CEO turnover after
including control variables that prior research has found to be associated with executive
turnover. Overall, neither the univariate tests (Figure 2) nor the multivariate tests
(Table 4) are consistent with reputational cost of tax shelter revelation manifesting in
increased CEO or CFO turnover.22
20. We do not require a retirement variable when examining CFO turnover because the data are available for
only about one-third of our sample. When we do require a retirement variable for CFO observations,
inferences are the same (untabulated).
21. Ai and Norton (2003) and Greene (2010) show that several mainstream statistical packages incorrectly cal-
culate interaction eects in nonlinear models such logit regressions. However, Kolasinski and Siegel (2010)
argue that the interaction eects presented by these statistical packages are economically meaningful. Our
interaction eects throughout the paper are calculated as usual, but inferences are robust to using the
inte procedure in Stata developed by Ai and Norton.
22. One possibility for this nding is that the legal proceedings for a tax shelter are suciently longer than the
one-year window we evaluate. In subsequent tests we examine longer windows (up to three years) and nd
results consistent with the one-year results.
Figure 2 CEO, CFO, and auditor turnover before and after tax shelter revelation
16
14
12
CEO Turnovers
10
0
-2 -1 0 1 2
Years Around Tax Shelter Revelation
4
CFO Turnovers
0
-2 -1 0 1 2
Years Around Tax Shelter Revelation
4
Auditor Turnovers
0
-2 -1 0 1 2
Years Around Tax Shelter Revelation
TABLE 4
Tax shelter revelation and top management turnover
(1) (2)
Variables CEO TURNOVER CEO TURNOVER
Notes:
This table presents the results of a logistic regression of an indicator for CEO turnover on tax
shelter variables and predicted determinants of executive turnover. CEO TURNOVER is an
indicator variable equal to one if the rms CEO changed that year, and zero otherwise.
CAUGHTFIRM is an indicator variable equal to one if the rm has ever been revealed as
having a tax shelter (i.e., a treatment rm), and zero otherwise. CAUGHTYEAR is an
indicator variable equal to one, for both the treatment and matched control rm, in the year it
was revealed that the treatment rm had engaged in a tax shelter, and zero otherwise. All
control variables are measured with a one-year lag and are as dened in the Appendix.
Coecients are presented with Z-statistics based on rm-clustered standard errors in
parentheses. ***, **, * represent signicance levels of 1 percent, 5 percent, and 10 percent,
respectively, all for two-tailed tests.
Does tax shelter scrutiny inuence sales revenue and advertising expense?
We next examine whether rms accused of engaging in tax shelters suer lost sales from
customers and whether they had to increase advertising as a result. In this estimation of
(1), SALES and AD EXPENSE are the dependent variables (both in levels and in changes
form), and are dened in the Appendix. When SALES is the dependent variable, b3 < 0
would indicate a reduction of sales revenue for rms following adverse media coverage
accusing them of being in a tax shelter. If rms respond to the negative publicity from the
media coverage by increasing their advertising expenditures, then we expect b3 > 0 when
AD EXPENSE is the dependent variable. Both ndings would be consistent with rms
suering reputational costs from aggressive tax avoidance. We include a number of con-
trol variables in this implementation of (1) including SIZE, PPE, DPPE, LEVERAGE,
INTANGIBLE ASSETS, R&D EXPENSE, AD EXPENSE, NOL DUMMY, DNET
TABLE 5
Tax shelter revelation and sales revenue and advertising expense
Notes:
This table presents the results of OLS regression of sales and advertising expense on tax shelter
variables and control variables. SALES (AD EXPENSE) is sales (advertising expense), divided
by average total assets. DSALES (DAD EXPENSE) is the change in sales (advertising
expense), divided by average total assets. CAUGHTFIRM is an indicator variable equal to one
if the rm has ever been revealed as having a tax shelter (i.e., a treatment rm), and zero
otherwise. CAUGHTYEAR is an indicator variable equal to one, for both the treatment and
matched control rm, in the year it was revealed that the treatment rm had a engaged in a
tax shelter, and zero otherwise. All other variables are as dened in the Appendix. Coecients
are presented with t-statistics based on rm-clustered standard errors in parentheses. ***, **,
and * represent signicance levels of 1 percent, 5 percent, and 10 percent, respectively, all for
two-tailed tests.
TABLE 6
Tax shelter revelation and rm reputation in the media
(1) (2)
Variables ADMIREDt+1 ADMIREDt+1
Notes:
This table presents the results of a logistic regression of rm reputation in the media on tax shelter
variables and control variables. Our proxy for rm reputation in the media is ADMIRED,
which is an indicator variable equal to one if the rm-year is included on Fortune Magazines
Most Admired Companies list, and zero otherwise. CAUGHTFIRM is an indicator variable
equal to one if the rm has ever been revealed as having a tax shelter (i.e., a treatment rm),
and zero otherwise. CAUGHTYEAR is an indicator variable equal to one, for both the
treatment and matched control rm, in the year it was revealed that the treatment rm had
engaged in a tax shelter, and zero otherwise. All other variables are as dened in the
Appendix. Coecients are presented with Z-statistics based on rm-clustered standard errors
in parentheses. ***, **, and * represent signicance levels of 1 percent, 5 percent, and 10
percent, respectively, all for two-tailed tests.
TABLE 7
The eect of reputation on tax shelter participation
Panel B: Percentage of rm-years with above median advertising expense by tax shelter status
Notes:
This table reports dierences in the proportion of sample rms with a tax shelter based on measures
for high and low reputation. The proxy for reputation is the rms inclusion on Fortune Most
Admired Companies or Best Companies to Work For list (ADMIRED & BEST) or by the
level of advertising expense (AD EXPENSE). Panel A measures high reputation as being
included on one of the two Fortune lists. Panel B measures high reputation as having
advertising expense above the median in a given year. For panels A and B, rm-years are
classied as either being shelter rm-years (i.e., rms in our treatment sample) or control rm-
years (all nontreatment rm-years on COMPUSTAT with total assets greater than $10
million). Panel A covers the period 19982010 and panel B covers the period 19832010.
Proportional dierences are tested using a two-sample t-test, and ***, **, * represent
signicance levels of 1 percent, 5 percent, and 10 percent, respectively, all for two-tailed tests.
23. Some research suggests that aggressive tax avoiders are more likely to inate their sales or earnings (e.g.,
Frank et al. 2009). If we had found a decline in sales following tax shelter scrutiny that would have made
interpretation of the decline more dicult, since it could have been due to actual lost sales or due to the
rm curtailing its sales-inating behavior. In an untabulated analysis, we nd that inferences are
unchanged if we examine operating cash ows instead of sales.
TABLE 8
The likelihood of tax shelter participation and reputation
(1) (2)
Variables Shelter dummy Shelter dummy
Notes:
This table presents the results of a logistic regression of tax shelter participation on tax shelter
predictor variables and reputational variables, as in Wilson (2009) and Lisowsky (2010). For
the purposes of this test, all years in which the rm was actively engaged in a tax shelter are
collapsed into one observation, and all independent variables are calculated yearly then
averaged over the shelter period. Treatment rms are matched to a rm in the same industry
with the closest total assets in the rst tax shelter year. The dependent variable is an indicator
variable equal to one if the observation is a tax shelter, and zero otherwise. Column (1)
contains all reputational proxies except for ADMIRED, and column (2) contains all
reputational proxies. Reputational proxies include R&D EXPENSE, AD EXPENSE, MTB,
INTANGIBLE ASSETS, SENSITIVE INDUSTRIES, and ADMIRED. All variables are
dened in the Appendix. Coecients are presented with Z-statistics based on rm-clustered
standard errors in parentheses. ***, **, * represent signicance levels of 1 percent, 5 percent,
and 10 percent, respectively, all for two-tailed tests.
Thus, across all models, we nd no evidence of a signicant reputational eect of tax shel-
ter revelation that manifests in the form of reduced sales or increased advertising expense.
Fortune Most Admired Companies list as a proxy for a high overall reputation.24 Specif-
ically, we estimate (1) in logistic form with ADMIRED as the dependent variable, where
ADMIRED is an indicator set equal to one if the rm makes the Fortune list in a given
year, and zero otherwise.25 If rms suer signicant costs to their overall reputation in the
media from tax shelter behavior, then we expect b3 < 0. We note that all of the rms in
the sample are the subject of media scrutiny for their tax shelter use since that was a
requirement to be in the sample. Thus, this test is an assessment of whether the scrutiny
over one particular activity (i.e., tax shelter use) has adverse eects on the rms overall
reputation in the media. In Table 6, we nd no evidence that, relative to the control sam-
ple, rms with tax shelters experience a signicant change in their reputation once the tax
shelter is made public. Many of the control variables are statistically signicant in the
direction one would expect.
5. Additional tests
Reputation and tax shelter engagement
The prior tests have examined the ex post consequences to the rm reputation from public
scrutiny of tax shelter involvement. In this subsection, we examine whether the rms rep-
utation is associated with the ex ante probability of engaging in a tax shelter. Panel A of
Table 7 reports the frequency with which rms on the Fortune Best Companies To Work
For or Most Admired Companies lists are identied as having engaged in a tax shelter,
compared to publicly traded rms that do not make either of the Fortune lists. The data
do not indicate that high reputation rms avoid engaging in tax shelters. Firm-years that
make Fortunes lists have an 18 percent chance of being in our tax shelter sample, whereas
rm-years not on the Fortune lists have about a 1.5 percent chance of being in our tax
shelter sample. Finding that high reputation rms engage in tax sheltering is consistent
with the tax sheltering resulting in little or no reputational cost. However, another possi-
bility is that high reputation rms are immune to reputational costs. Perhaps some rms
have innately high reputations without incurring costs to build those reputations. Accord-
ingly, in panel B we examine actual advertising expenditures to reect reputations that are
costly to build. The results in panel B also do not suggest that high reputation rms avoid
tax shelters. We are careful to emphasize, however, that these are merely univariate tests.
In Table 8, we extend these univariate tests to the multivariate setting to control for
other determinants of tax shelter usage, following Wilson (2009) and Lisowsky (2010). For
this test, we only use shelter rms for which we have data on when the rm was actively
participating in the shelter. We collapse all years in which the rm was actively participat-
ing in a shelter into one observation, and we match each shelter-rm to a rm in the same
industry with closest total assets in the rst shelter participation year. We estimate a logis-
tic regression of tax shelter usage (SHELTER) on variables from prior research associated
with tax shelter usage and a number of proxies for reputational sensitivity: research and
development (R&D EXPENSE), AD EXPENSE, the rms market-to-book ratio (MTB),
intangible assets (INTANGIBLE ASSETS), an indicator variable (SENSITIVE INDUS-
TRIES) for rms in the industries that are likely to be especially sensitive to reputational
concerns, and ADMIRED as follows:26
24. The Fortune lists can be found at: http://money.cnn.com/magazines/fortune/most-admired/ and http://
money.cnn.com/magazines/fortune/best-companies/, accessed May 13, 2013.
25. We also use the rms presence on the Fortune Best Companies to Work For list. Inferences are
unchanged if we use an alternate dependent variable, ADMIRED & BEST, equal to one if a rm makes
either list in that year, and zero otherwise (results untabulated).
26. Specically, SENSITIVE INDUSTRIES is equal to one for rms in the food products, healthcare, retail,
and nancial industries, according to the Fama-French 30 industry classication.
We include the market-to-book ratio, intangible intensity, and research and develop-
ment as measures of reputational sensitivity because rms with high growth opportunities,
high intangibles, or high research and development operate in businesses where explicit
contracts are costly to write and enforce, which places more reliance on the trust of man-
agement by outside parties.27 Since this empirical specication is quite similar to that in
Wilson (2009), we include a vector of control variables similar to the one used in that
study.
The results in Table 8 reveal that several factors are associated with the likelihood of
shelter participation, including discretionary accruals and return on assets, consistent with
the ndings in prior studies.28 However, in neither column do we observe any of the repu-
tation variables being signicantly associated with tax shelter use. Overall, these results do
not suggest that rm-level reputation concerns aect whether rms engage in these tax
shelters.
27. We thank a referee for this suggestion. We also acknowledge that intangible intensity and research and
development can proxy for other factors as well, including tax avoidance incentives and activities, which
could complicate interpretation of those variables.
28. In column (1) of Table 8, we present the results with all explanatory variables except for ADMIRED,
because this variable is not available for part of the sample period and reduces the sample size. In column
(2) we present the results with the full set of explanatory variables, including ADMIRED.
29. We follow the design of Collins and McInnis (2011). The dependent variable in the propensity score model
is an indicator variable equal to one if the rm is a shelter rm and zero otherwise. The sample for this
test spans the period for which we have shelter revelations. Each rm is represented once in the regression;
if control rms have more than one eligible rm-year in the period, we randomly select one of those rm-
years to be included. All variables are measured the year before the revelation.
30. Because not all of the variables examined by Lisowsky (2010) are readily available, we use the reduced pre-
diction model from that paper, which is similar to the model in Wilson (2009).
Table S9 presents the propensity score regression (panel A) and the replication of
Tables 46 using each of these alternate control samples (panels B and C).31 The propen-
sity score regression shows sucient ability to predict variation in tax sheltering with a
psuedo R2 of 33 percent. Across panels B and C, the coecient testing for reputation
eects is signicant in the predicted direction in only one regression out of 12.
31. Please see supporting information, Table S9: Alternate control groups as an addition to the online article.
32. Please see supporting information, Table S10: Dierent time horizons as an addition to the online article.
33. We note that COLI rms make up nearly half of our sample but do not appear to be strongly dierent
from non-COLI rms. We nd signicant dierences between COLI and non-COLI rms in only 3 of 25
descriptive variables (SIZE, PPE, and SENSITIVE INDUSTRIES; tests unreported).
that for each of these subsamples, we face a trade-o in that we focus even more sharply on
those rms likely to suer reputational costs of tax avoidance, but at the cost of a decrease
in the number of observations.
We estimate the regressions from Tables 4, 5, and 6 on these seven dierent sample
partitions and, for parsimony, present only the coecients on the interaction term
(CAUGHTFIRM * CAUGHTYEAR) in Table S11.34 Hence, with six dierent dependent
variables and seven dierent sample partitions, Table S11 presents the interaction coe-
cients from 42 estimations of equation (1). The results show that all 42 test coecients are
insignicant.
6. Conclusion
Across a multititude of tests, we do not nd evidence that rms or their top executives
face signicant reputational costs from tax shelter involvment. The only exception is a
temporary decline in stock price around tax shelter revelations that fully reverses within
30 days. When weighed against the large benets to after-tax earnings from tax avoidance
documented in Dyreng et al. (2008), the evidence in this paper casts doubt on reputational
costs as a primary factor in explaining the under-sheltering puzzle, in which some rms
take advantage of tax sheltering opportunities while others do not.
This paper also contributes to the literature on corporate misconduct, which has a
long history in nance and accounting, including studies of managerial and corporate
fraud, accounting restatements, and environmental violations. Across these studies, the
evidence is mostly consistent that capital markets and labor markets exert heavy reputa-
tional penalties for corporate misconduct. However, our results suggest that rms and
executives engaged in tax avoidance do not face signicant reputational consequences,
which is consistent with tax sheltering not being perceived as in the same category as mis-
conduct. There are several possible explanations for the lack of an empirical association
between tax sheltering and reputation penalties. First, if some stakeholders prefer tax
avoidance while others do not, the net eect on a rms reputation may be zero. Second,
some stakeholders prefer that managers take appropriate risks, one of which may be
tax sheltering (Rego and Wilson 2012). Finally, stakeholders may view tax sheltering as
34. Please see supporting information, Table S11: Subsample analyses as an addition to the online article.
35. Our inferences remain the same if we use multivariate tests to control for cross-sectional and time-series
determinants of ETRs (tests unreported).
Figure 3 Eective tax rates before and after tax shelter revelation
40%
38%
36%
Cash Effective Tax Rate 34%
32%
30%
28%
26%
24%
22%
20%
-2 -1 0 1 2 3 4 5
Years Around Tax Shelter Revelation
40%
38%
36%
GAAP Effective Tax Rate
34%
32%
30%
28%
26%
24%
22%
20%
-2 -1 0 1 2 3 4 5
Years Around Tax Shelter Revelation
Notes:
This gure plots the eective tax rates (ETRs) for treatment and control rms in event time around
the rst revelation that the treatment rm has engaged in a tax shelter. Treatment rms are
rms that are publicly revealed to have been engaging tax sheltering, while control rms are
matched to treatment rms on total assets within the same industry in the year before shelter
revelation. Panel A presents the CASH ETR, which is measured as cash taxes paid divided by
adjusted pre-tax income (pre-tax income minus special items). Panel B presents the GAAP
ETR, which is measured as current tax expense divided by pre-tax income. The y-axis shows
the mean ETR, and the x-axis shows the year the ETR mean is calculated in relation to the
year in which the shelter was revealed (year 0). Both ETR measures are winsorized at 0 and 1.
dierent from corporate misdeeds and thus not react in the same way to tax shelter news
as they would to news of corporate misconduct.
Moreover, the empirical results are subject to some interrelated caveats. First,
although we use tax shelters to focus on aggressive tax strategies, by denition our sample
consists of tax shelters that were actually implemented. It is entirely possible that there are
tax shelters so egregious that no rm implements them due to reputational concerns, and
we cannot generalize to tax strategies that are never implemented. Second, rms and man-
agers self-select into tax shelters, which means that it is possible that some rms forgo the
tax benets of sheltering to avoid jeopardizing their good name. While there is no way
fully to rule out this possibility, we test this directly and nd no association between the
decision to engage in a tax shelter and several measures of reputation. Third, we can only
speak to the reputational costs that we examine. Reputation is a broad concept that
means dierent things to dierent people. We have endeavored to consider reputational
costs imposed by a wide variety of parties (e.g., shareholders, customers, and tax authori-
ties) that could manifest in various ways (e.g., managerial turnover, lost sales, and
increased taxes). Despite our best eorts, however, it is possible that there are reputational
costs of some form that we have not examined. For example, it is possible that lower-level
executives, such as those in the tax department, do suer turnover or other reputational
costs. This is worthy of future inquiry. Fourth, it is possible that using other methodolo-
gies, including survey, case, and clinical research methodologies, may yield dierent infer-
ences from those we nd. We welcome more research on the subject.
In terms of future research, the results suggest that the under-sheltering puzzle is
more of a puzzle than ever. If we assume that rms are acting optimally, there must be
costs of tax avoidance that prevent more rms from engaging in it, but so far they have
proved largely elusive. The evidence here suggests that reputational consequences, at least
as they manifest at the rm level, are unlikely to be a major factor in explaining under-
sheltering. Other costs can explain only small pieces of the puzzle. For example, nancial
reporting costs exist for certain tax avoidance strategies, but there are whole classes of tax
strategies for which there is no nancial reporting trade-o (Badertscher et al. 2009). The
question of why some rms forgo tax avoidance, while others enthusastically engage in it,
is very much an open question in the literature. We look forward to future research on
the question.
Appendix
Variable measurements and descriptions
*Appendix (continued)
(continued)
NOL DUMMY Indicator variable equal to one if net operating loss COMPUSTAT
carryforward is positive, and zero otherwise
PPE Average property, plant and equipment, divided by COMPUSTAT
average total assets
DPPE PPE minus last years property, plant and COMPUSTAT
equipment, divided by average total assets
R&D EXPENSE Research and development expense, divided by COMPUSTAT
average total assets
ROA Net income, divided by average total assets COMPUSTAT
SENSITIVE Indicator variable equal to one if rm is in the food, COMPUSTAT
INDUSTRIES healthcare, retail, or nancial industries (using the
Fama-French 30 classication), and zero otherwise
SIZE Natural log of average total assets COMPUSTAT
SPECIAL ITEMS Special items, divided by average total assets COMPUSTAT
References
Agrawal, A., J. Jae, and J. Karpo. 1999. Management turnover and governance changes following
the revelation of fraud. Journal of Law and Economics 42 (1): 30942.
Ai, C., and E. Norton. 2003. Interaction terms in logit and probit models. Economic Letters 80 (1):
12329.
Armstrong, C., J. Blouin, and D. Larcker. 2012. The incentives for tax planning. Journal of Account-
ing and Economics 53 (12): 391411.
Badertscher, B., J. Phillips, M. Pincus, and S. Rego. 2009. Earnings management strategies and the
trade-o between tax benets and detection risk: To conform or not to conform? The Account-
ing Review 84 (1): 6397.
Bankman, J. 1999. The new market in U.S. corporate tax shelters. Tax Notes International 18: 2681
706.
Beneish, M. 1999. Incentives and penalties related to earnings overstatements that violate GAAP.
The Accounting Review 74 (4): 42557.
Bowen, R., A. Call, and S. Rajgopal. 2010. Whistle-blowing: Target rm characteristics and eco-
nomic consequences. The Accounting Review 85 (4): 123971.
Brown, J. 2011. The spread of aggressive tax reporting: A detailed examination of the corporate-
owned life insurance shelter. The Accounting Review 86 (1): 2357.
Davis, A., D. Guenther, L. Krull, and B. Williams. 2013. Taxes and corporate accountability report-
ing: Is paying taxes viewed as socially responsible? Working paper, University of Oregon.
Dechow, P., R. Sloan, and A. Sweeney. 1996. Causes and consequences of accounting manipulation:
an analysis of rms subject to enforcement actions by the SEC. Contemporary Accounting
Research 13 (1): 136.
Decker, W. 2010. A rms image following alleged wrongdoing: Eects of the rms prior reputation
and response to the allegation. Corporate Reputation Review 15 (Spring): 2034.
Desai, H., C. Hogan, and M. Wilkins. 2006. The reputational penalty for aggressive accounting:
earnings restatements and management turnover. The Accounting Review 81 (1): 83112.
Desai, M., and D. Dharmapala. 2006. Corporate tax avoidance and high-powered incentives. Journal
of Financial Economics 79 (1): 14579.
Dyreng, S., M. Hanlon, and E. Maydew. 2008. Long-run corporate tax avoidance. The Accounting
Review 83 (1): 6182.
Dyreng, S., M. Hanlon, and E. Maydew. 2010. The eects of executives on corporate tax avoidance.
The Accounting Review 85 (4): 116389.
Dyreng, S., and B. Lindsey. 2009. Using nancial accounting data to examine the eect of foreign
operations located in tax havens and other countries on US multinational rms tax rates. Jour-
nal of Accounting Research 47 (5): 1283316.
Dyreng, S., B. Lindsey, and J. Thornock. 2013. Exploring the role Delaware plays as a domestic tax
haven. Journal of Financial Economics 108 (3): 75172.
Engel, E., M. Erickson, and E. Maydew. 1999. Debtequity hybrid securities. Journal of Accounting
Research 37 (2): 24974.
Engel, E., R. Hayes, and X. Wang. 2003. CEO turnover and properties of account information.
Journal of Accounting and Economics 36 (13): 197226.
Fombrun, C., and M. Shanley. 1990. Whats in a name? Reputation building and corporate strategy.
Academy of Management Journal 33 (2): 23358.
Frank, M., L. Lynch, and S. Rego. 2009. Tax reporting aggressiveness and its relation to aggressive
nancial reporting. The Accounting Review 84 (2): 46796.
Gilson, S. 1989. Management turnover and nancial distress. Journal of Financial Economics 25 (2):
24162.
Graham, J., and A. Tucker. 2006. Tax shelters and corporate debt policy. Journal of Financial Eco-
nomics 81 (3):56394.
Graham, J., M. Hanlon, T. Shevlin, and N. Shro. 2012. Incentives for tax planning and avoidance:
Evidence from the eld. The Accounting Review, forthcoming.
Greene, W. 2010. Testing hypotheses about interaction terms in nonlinear models. Economic Letters
107 (2): 29196.
Hanlon, M., and S. Heitzman. 2010. A review of tax research. Journal of Accounting and Economics
50 (23): 12778.
Hanlon, M., and J., Slemrod. 2009. What does tax aggressiveness signal? Evidence from stock price
reactions to news about tax shelter involvement. Journal of Public Economics 93 (12): 12641.
Hennes, K., A. Leone, and B. Miller. 2008. The importance of distinguishing errors from irregulari-
ties in restatement research: The case of restatements and CEO/CFO turnover. The Accounting
Review 83 (6): 1487519.
Jarell, G., and S. Peltzman. 1985. The impact of product recalls on the wealth of sellers. Journal of
Political Economy 93 (3): 51236.
Karpo, J., S. Lee, and G. Martin. 2008a. The consequences to managers for nancial misrepresen-
tation. Journal of Financial Economics 88 (2): 193215.
Karpo, J., S. Lee, and G. Martin. 2008b. The cost to rms of cooking the books. Journal of Finan-
cial and Quantitative Analysis 43 (3): 581612.
Karpo, J., J. Lott, and E. Wehrly. 2005. The reputational penalties for environmental violations:
Empirical evidence. Journal of Law and Economics 48: 65375.
Kothari, S. P., A. Leone, and C. Wasley. 2005. Performance matched discretionary accrual mea-
sures. Journal of Accounting and Economics 39 (1): 16397.
Kolasinki, A., and A. Seigel. 2010. On the economic meaning of interaction terms coecients in
non-linear binary response regression models. Working paper, University of Washington.
Lisowsky, P. 2010. Seeking shelter: Empirically modeling tax shelters using nancial statement infor-
mation. The Accounting Review 85 (5): 1693720.
Lisowsky, P., L. Robinson, and A. Schmidt. 2012. Do publicly disclosed tax reserves tell us about
privately disclosed tax shelter activity? Journal of Accounting Research 51 (3): 583629.
Maydew, E. 2001. Empirical tax research in accounting: A discussion. Journal of Accounting and
Economics 31 (13): 389403.
Maydew, E., and D. Shackelford. 2007. The changing role of auditors in corporate tax planning. In
Taxing Income in the 21st Century, eds. Joel Slemrod and Alan Auerbach, 30737. University of
Michigan Oce of Tax Policy Research / University of California at Berkeley Burch Center,
Cambridge University Press.
McInnis, J., and D. Collins. 2011. The eect of cash ow forecasts on accrual quality and bench-
mark beating. Journal of Accounting and Economics 51 (3): 21939.
Menon, K., and D. Williams. 2008. Management turnover following auditor resignations. Contempo-
rary Accounting Research 25 (2): 567604.
Mills, L., S. Nutter, and C. Schwab. 2013. The eect of political sensitivity and bargaining power on
taxes: Evidence from federal contractors. The Accounting Review, forthcoming.
Rego, S., and R. Wilson. 2012. Equity risk incentives and corporate tax aggressiveness. Journal of
Accounting Research 50 (3): 775810.
Robinson, J., S. Sikes, and C. Weaver. 2010. The impact of evaluating the tax function as a prot
center on eective tax rates. The Accounting Review 85 (4): 103564.
Scholes, M., P. Wilson, and M. Wolfson. 1990. Tax planning, regulatory capital planning, and nan-
cial reporting strategy for commercial banks. Review of Financial Studies 3 (4): 62550.
Schultz, E., and T. Francis. 2002. Companies prot on workers deaths through dead peasants
insurance. Wall Street Journal, April 19.
Shackelford, D., and T. Shevlin. 2001. Empirical tax research in accounting. Journal of Accounting
and Economics 31 (13): 32187.
Sheppard, L. 1995. News analysis: Janitor insurance as a tax shelter. Tax Notes 68 (September
25): 1526.
Shulman, D. 2009. Speech to the National Association of Corporate Directors Governance Confer-
ence, October 19.
Srinivasan, S. 2005. Consequences of nancial reporting failure for outside directors: Evidence from
accounting restatements and audit committee members. Journal of Accounting Research 43 (2):
291334.
Walker, K. 2010. A systematic review of the corporate reputation literature: Denition, measure-
ment, and theory. Corporate Reputation Review 12 (Winter): 35787.
Watson, L. 2011. Corporate social responsibility and tax aggressiveness: An examination of unrecog-
nized tax benets. Working paper, Pennsylvania State University.
Weisbach, D. 2002. Ten truths about tax shelters. Tax Law Review 55: 21553.
Wilson, R. 2009. An examination of corporate tax shelter participants. The Accounting Review 84 (3):
96999.
Zimmerman, J. 1983. Taxes and rm size. Journal of Accounting and Economics 5: 11949.
SUPPORTING INFORMATION
Additional Supporting Information may be found in the online version of this article:
Table S9. Alternate control groups.
Table S10. Dierent time horizons.
Table S11. Subsample analyses.