We classify all institutional investors that file Form 13-F over the period 1995–2013 as either “tax-sensitive” or “tax-insensitive” based on their trading behavior and portfolio characteristics. We examine tests of the effects of investor tax-sensitivity on portfolio rebalancing, price pressure, and fund performance, and compare our measure of tax-sensitive institutional investor ownership to three measures used in prior studies. We show that our measure of tax-sensitive investors dominates other measures in the portfolio rebalancing and price pressure tests. In the fund performance test, our measure of tax-sensitivity is the only one that finds that tax-sensitive investors have significantly lower returns on their portfolio stocks, which is a new result in the literature.

We investigate why firms choose to evaluate a tax department as a profit center (“contributor to the bottom line”) as opposed to as a cost center and the association between this choice and effective tax rates (ETRs). Using data from a confidential survey taken in 1999 of Chief Financial Officers, we develop and test a theory for choosing between these two methods of evaluating a tax department. We find that the likelihood of evaluating the tax department as a profit center is increasing in firm decentralization characteristics and tax-planning opportunities. We then employ instrumental variables to investigate whether evaluating a tax department as a profit center provides an effective incentive for the tax department to contribute to net income through lower ETRs. We find that our instrument for profit center firms is associated with significantly lower ETRs than cost center firms.