We identify a pecuniary externality arising from corporate tax avoidance. Firms share risk with the government via taxation. The lower the tax rate applied to a firm’s earnings, the more risk its shareholders bear. As more firms avoid taxes, the variance of the market’s after-tax cash flow increases. Consequently, the covariance of a firm’s cash flow with the market cash flow and thereby its cost of capital increases. This occurs regardless of a firm’s tax avoidance. Consistent with our prediction, we find that firms’ implied cost of capital relates positively to aggregate corporate tax avoidance regardless of a firm’s level of tax avoidance. As we predict, the pecuniary externality is stronger for firms whose cash flow covaries more with the market cash flow and is driven by tax avoidance strategies that reduce a firm’s marginal tax rate (e.g., income shifting of U.S. multinationals) as opposed to reducing its tax base.

Classical models of voluntary disclosure feature two economic forces: the existence of an adverse selection problem (e.g., a manager possesses some private information) and the cost of ameliorating the problem (e.g., costs associated with disclosure). Traditionally these forces are modelled independently. In this paper, we use a simple model to motivate empirical predictions in a setting where these forces are jointly determined––where greater adverse selection entails greater costs of disclosure. We show that joint determination of these forces generates a pronounced non-linearity in the probability of voluntary disclosure. We find that this non-linearity is empirically descriptive of multiple measures of voluntary disclosure in two distinct empirical settings that are commonly thought to feature both private information and proprietary costs: capital investments and sales to major customers.