We examine the issue prices of small initial public offerings around the 1993 tax law change that reduced the capital gains tax on qualified small business stock. We compare the actual issue price of new stock with a benchmark price that is not affected by the change in capital gains tax. We find that, after controlling for IPO underpricing, the issue prices of qualifying small business stock after the tax rate change are significantly higher than the issue prices before the change. A control sample of nonqualifying firms shows no significant difference in issue prices.

We investigate how shareholder taxes and risk preferences affect both a stock’s expected return, which reflects the capitalization of the dividend tax penalty into stock price, and the fraction of a firm’s stock held by tax-exempt investors. Our model demonstrates that the dividend tax capitalization effect reflects the weighted average tax rate of all investors, where the weighting depends on investors’ risk tolerances. This weighted average tax rate is not affected by the fraction of stock held by tax-exempt investors; however, tax-exempt investor ownership can be correlated with the weighted average tax rate if differences in tax-exempt investor ownership for different stocks reflect differences in investor risk tolerances for those stocks. Our empirical tests are consistent with the model’s predictions, and provide an equilibrium framework for interpreting prior empirical studies in accounting.

We investigate the role of book-tax conformity in firms' financial reporting activities using a unique set of publicly traded firms that were forced to switch for tax purposes from the cash method to the accrual method. Prior to the mandated change, little trade-off existed between tax planning and financial reporting goals for these firms. After the change, recognition criteria for tax and financial reporting purposes became more alike, increasing the trade-off between financial reporting and tax objectives. Our results suggest that required use of the accrual method for tax purposes causes firms to defer income for financial statement purposes.

We investigate the relation between tax rates and pretax returns by showing how implicit tax, tax incidence, and tax capitalization change in response to a tax rate change. We examine these issues in the context of both financial assets and real investments made by corporations in a competitive equilibrium in which all investments earn the same after-tax rate of return. Results show that the pretax return increases in the statutory tax rate due to an explicit tax rate effect and decreases due to a cost of capital effect; the net effect is ambiguous. In contrast, the implicit tax rate is weakly increasing in the statutory tax rate. We also relate our findings to the empirical literature on the effects of taxes on pretax returns.

This study examines the effect on firm value of repealing the last-in, first-out (LIFO) inventory method for tax purposes. Our model extends prior literature by determining quantities and prices in equilibrium, rather than specifying them exogenously. We find that LIFO repeal could increase the future after-tax cash flows of firms that had used LIFO, because the higher tax costs associated with FIFO result in lower equilibrium quantities and higher equilibrium output prices, which increase pretax cash flows. We illustrate our model by examining inventory methods used by firms in the oil industry.

This paper compares two attributes of a deferred tax liability (DTL) that arise from differences in book and tax depreciation methods. The first attribute is the effect of the DTL on the market value of the firm. The second is the length of time between when the asset is placed into service and when the DTL associated with that asset begins to reverse. The paper shows that a decrease in the time it takes for the DTL to begin to reverse is neither necessary nor sufficient for the value of the DTL to increase. It also shows that the value of the DTL is not equal to the present value of the future deferred tax expense. The effect of one dollar of DTL on firm value depends only on the tax depreciation rate and the discount rate.

This study uses an analytical model to investigate the value of the firm when there are temporary differences between when revenue and expense items are recognized for tax- and financial-reporting purposes. The model shows that deferred tax assets and liabilities transform book values of underlying liabilities and assets into estimates of the after-tax cash flows on which the firm's market value is based. The analysis shows that if tax deductions are taken on a cash basis, and if the underlying assets and liabilities are recorded at the present value of their associated future cash flows, then the value of deferred tax assets and deferred tax liabilities is their recorded amount, regardless of when the asset will be realized or when the liability will reverse. If tax deductions are not taken when the expenditure is made (e.g., depreciation) or if underlying assets and liabilities are recorded at more than the present value of their associated future cash flows (e.g., warranty liabilities), then the market value of deferred tax assets and deferred tax liabilities is less than their recorded values. The value of the deferred tax account is independent of when that account will reverse.

We test whether tax avoidance strategies are associated with greater firm risk. We find that low tax rates tend to be more persistent than high tax rates and that measures of tax avoidance commonly used in the literature are generally not associated with either future tax rate volatility or future overall firm risk. Our evidence suggests that, on average, corporate tax avoidance is accomplished using strategies that are persistent and do not increase firm risk. We also find that the volatility of cash tax rates is associated with future stock volatility, suggesting that tax rate volatility and overall firm risk are related.

We provide evidence about allocations of cash flow freed up by not paying taxes (“tax-related cash”). Uncertainty about future repayments suggests firms may use tax-related cash more cautiously than other cash flow. We utilize a flow-of-funds model from finance to quantify the relative amounts of tax-related cash associated with various potential uses of operating cash flow. We find firms allocate tax-related cash differently than other after-tax cash flow. Prior studies find tax avoiders hold more cash, and our results suggest this is because firms invest less (and save more) tax-related cash. We also find that the allocation of tax-related cash varies with relative financial constraints, economic uncertainty, and firms' multinational status in ways consistent with prior findings. For example, firms facing relatively higher levels of financial constraints invest a lower (higher) percentage of tax-related cash in capital expenditures (marketable securities and R&D), possibly to preserve funds for future investment opportunities.

We investigate whether tax avoidance becomes more uncertain as the rate of tax avoidance increases. We estimate a system of equations to demonstrate that as firms' pretax income increases, each additional dollar of potential tax results, on average, in 32.8 cents of tax avoided, which we refer to as incremental tax avoidance. Of the incremental tax avoided, 1.4 cents represent additions to the reserve for uncertain tax benefits (UTB reserve), or 4.3 percent of the total incremental tax avoided. We then partition sample firms into groups that prior research suggests engage in higher rates of tax avoidance, and examine the amount of incremental tax avoidance that results in additions to the UTB reserve. Results demonstrate that the percentage of incremental tax avoidance reflecting additions to UTB reserve is not larger for groups engaging in higher rates of tax avoidance, suggesting higher rates of tax avoidance may not be more uncertain.