ABSTRACT This study examines equity risk incentives as one determinant of corporate tax aggressiveness. Prior research finds that equity risk incentives motivate managers to make risky investment and financing decisions, since risky activities increase stock return volatility and the value of stock option portfolios. Aggressive tax strategies involve significant uncertainty and can impose costs on both firms and managers. As a result, managers must be incentivized to engage in risky tax avoidance that is expected to generate net benefits for the firm and its shareholders. We predict that equity risk incentives motivate managers to undertake risky tax strategies. Consistent with this prediction, we find that larger equity risk incentives are associated with greater tax risk and the magnitude of this effect is economically significant. Our results are robust across four measures of tax risk, but do not vary across several proxies for strength of corporate governance. We conclude that equity risk incentives are a significant determinant of corporate tax aggressiveness.

ABSTRACT We investigate why temporary book-tax differences appear to serve as a useful signal of earnings persistence (Hanlon 2005). We first test and show that temporary book-tax differences provide incremental information over the magnitude of accruals for the persistence of earnings and accruals. We then opine that there are multiple potential sources of large positive book-tax differences. We predict and find that firms with large positive book-tax differences likely arising from upward earnings management (tax avoidance) exhibit lower (higher) earnings and accruals persistence than do other firms with large positive book-tax differences. Finally, we find significant variation in current-period earnings and accruals response coefficients and insignificant hedge returns in period t+1, consistent with investors being able to look through to the source of large positive book-tax differences (earnings management and tax avoidance), allowing them to correctly price the persistence of accruals for these subsamples. Data Availability: Data are available from public sources identified in the study.