Abstract

This study investigates whether stock market investors consider the tax and non－tax costs of tax avoidance strategies in the valuation of after－tax operating cash flow. We also examine whether investors take into account potential agency costs in their assessment of tax avoidance strategies. Analysis using 3,124 firm－year data of the firms listed on Korea Stock Exchange for the years 2002－2010 reveals that capital market participants discount firms with the cash savings from tax avoidance. We posit that an increase in tax audit possibility, uncertain sustainability of tax savings from tax avoidance, and non－tax costs of tax avoidance activities contribute to such discounts. Second, we find that corporate governance does not influence these relations. In Korea, tax shelters are not allowed and taxable income is calculated based on accounting income. These institutional features constrain the use of tax avoidance for managerial opportunism, consequently resulting in restrictive association between tax avoidance and agency costs. This study provides empirical evidence on the investors’ assessment of cash savings due to tax avoidance by considering the links among valuation process, tax avoidance, and after－tax cash flows. Prior studies on the association between tax avoidance and firm value suggest that an increase in after－tax cash flows can increase firm value, but they do not examine the valuation of after－tax cash flows. This study fills the gap.

Keywords

• tax avoidance
• firm value
• operating cash flows
• tax costs
• non－tax costs

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