Conforming Tax Avoidance and Capital Market Pressure

TLDR

The study develops a book‑tax conforming tax avoidance measure and examines its prevalence among public firms. The authors validate the measure using simulation analyses, LIFO/FIFO inventory method conversions, and samples of private and public firms, and then assess its prevalence among public firms. Validation tests confirm the measure captures book‑tax conforming transactions, and results show that firms’ use of such avoidance systematically varies with capital market pressures, offering new insights into the trade‑off between tax savings and financial reporting.

Abstract

ABSTRACT In this study, we develop a measure of corporate tax avoidance that reduces both financial and taxable income, which we refer to as “book-tax conforming” tax avoidance. We use simulation analyses, LIFO/FIFO inventory method conversions, and samples of private and public firms to validate our measure. We then investigate the prevalence of conforming tax avoidance within a sample of public firms. Results from the validation tests indicate that our measure of conforming tax avoidance successfully captures book-tax conforming transactions. Consistent with expectations, we also find that the extent to which public firms engage in conforming tax avoidance varies systematically with the capital market pressures. Our study develops a new measure of conforming tax avoidance that should be useful in future research and provides new insights on the extent to which public firms are willing to reduce income tax liabilities at the expense of reporting lower financial income.