ArticlePublisher preview available

Stock liquidity and corporate tax avoidance

March 2019
Review of Accounting Studies 24(7)

March 2019
24(7)

DOI:10.1007/s11142-018-9479-6

Authors:

Yangyang Chen

Leon Zolotoy

University of Melbourne

We show that firms with higher stock liquidity engage less in extreme (i.e., overly aggressive or overly conservative) tax avoidance. The effect of stock liquidity on tax avoidance is economically meaningful and robust across alternative measures of tax avoidance and stock liquidity. The findings also hold after controlling for potential endogenous effects. We further document that the effect of stock liquidity on tax avoidance is amplified for firms with high proportions of activist shareholders and attenuated for firms with high levels of stock price informativeness. Overall, our findings suggest that stock liquidity mitigates extreme tax avoidance by enhancing shareholders’ monitoring over firm management.

Stock liquidity across GAAP effective tax rate deciles. We plot the mean values of the one-year lagged stock liquidity against decile ranks of GAAP effective tax rate (GETR). LIQ is calculated as the additive inverse of the natural logarithm of the relative effective spread. Greater value of LIQ indicates higher stock liquidity. GETR is calculated as income taxes scaled by pre-tax income. Lower value of GETR indicates more aggressive tax avoidance.

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Stock liquidity and corporate tax avoidance

Yangyang Chen

&Rui Ge

&Henock Louis

&Leon Zolotoy

Published online: 14 January 2019

#Springer Science+Business Media, LLC, part of Springer Nature 2019

Abstract

We show that firms with higher stock liquidity engage less in extreme (i.e., overly

aggressive or overly conservative) tax avoidance. The effect of stock liquidity on tax

avoidance is economically meaningful and robust across alternative measures of tax

avoidance and stock liquidity. The findings also hold after controlling for potential

endogenous effects. We further document that the effect of stock liquidity on tax

avoidance is amplified for firms with high proportions of activist shareholders and

attenuated for firms with high levels of stock price informativeness. Overall, our

findings suggest that stock liquidity mitigates extreme tax avoidance by enhancing

shareholders’monitoring over firm management.

Keywords Stock liquidity .Tax avoidance .Agency conflicts

JEL Classification G10 .G30 .M40

1 Introduction

We examine the effect of stock liquidity on corporate tax avoidance. An emerging

stream of tax research suggests that separation of ownership and control induces

managers to engage in extreme levels of tax avoidance (Slemrod 2004; McGuire

et al. 2014). This perspective posits that tax avoidance is a risky investment and that

agency conflicts can lead to underinvestment or overinvestment in tax avoidance

(Armstrong et al. 2015). Consistent with this view, prior studies suggest that investors

Review of Accounting Studies (2019) 24:309–340

https://doi.org/10.1007/s11142-018-9479-6

*Rui Ge

gerui@szu.edu.cn

School of Accounting and Finance, Hong Kong Polytechnic University, Hong Kong, China

Shenzhen Audencia Business School - Shenzhen University, Shenzhen, China

Department of Accounting, Pennsylvania State University, State College, PA, USA

Melbourne Business School, University of Melbourne, Melbourne, Australia

Content courtesy of Springer Nature, terms of use apply. Rights reserved.

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