Does Tax Aggressiveness Reduce

Corporate Transparency?
Karthik Balakrishnan
London Business School
Email: kbalakrishnan@london.edu
Jennifer Blouin*
University of Pennsylvania
Email: blouin@wharton.upenn.edu
Wayne Guay
University of Pennsylvania
Email: guay@wharton.upenn.edu

Current draft: September 27, 2014

ABSTRACT
This paper investigates whether aggressive tax planning firms have less transparent information
environments. Although tax planning provides expected tax savings, it can simultaneously
increase the financial complexity of the organization. And, to the extent that this greater financial
complexity cannot be adequately communicated to outside parties, such as investors and
analysts, transparency problems can arise. Our investigation of the association between a newly
developed measure of tax aggressiveness and information asymmetry, analyst forecast errors,
and earnings quality suggests that aggressive tax planning decreases corporate transparency. We
also find evidence, however, that managers at tax aggressive firms attempt to mitigate these
transparency problems by increasing the volume of tax-related disclosure. Overall, our results
suggest that firms face a trade-off between financial transparency and aggressive tax planning
thereby potentially explaining why some firms appear to engage in more conservative tax
planning than would otherwise be optimal.
JEL Classification: H20; M41
Keywords: Tax aggressiveness; tax planning; corporate transparency; disclosure
* Corresponding author. We appreciate comments from seminar participants at the University of Auckland,
University of Colorado, University of Connecticut, London Business School, University of Melbourne, and Tilburg
University.

1.

Introduction
Corporations engage in various forms of tax planning to reduce expected tax liabilities.

These expected benefits, however, do not come without costs. Such costs include direct labor
and information systems necessary to carry out the tax planning, as well as expected costs of
negotiation and penalties stemming from interactions with taxing authorities. In this paper, we
examine a further cost of tax planning, specifically that aggressive tax planning can reduce
financial transparency.
Although tax planning provides expected tax savings, it often also simultaneously
increases financial and organizational complexity.1 And, to the extent that this greater
complexity cannot be adequately communicated to outside parties, such as equity investors,
creditors, and analysts, transparency problems can arise. Bushman, Chen, Engel, and Smith
(2004, p. 175) describe this transparency potential problem as follows:
Operational complexities can arise as firms act to arbitrage institutional restrictions such
as tax codes and financial restrictions (Bodnar et al., 1998). For example, firms may
employ complex transfer pricing schemes to shift profits to low tax jurisdictions that can
complicate efforts by shareholders and board members to understand firms foreign
operations.

Of course, managers may respond to this greater financial complexity by augmenting

financial reporting and disclosures in an attempt to maintain a transparent information
1

Drucker (2010) provides an illustration of this complexity through a description of a Double Irish tax planning
technique used by pharmaceutical firm Forest Laboratories. Forest Laboratories Irish subsidiary, Forest
Laboratories Holdings Ltd., reorganized in 2005 by creating a new Irish subsidiary, Forest Laboratories Ireland, and
relocating itself to Bermuda. The Irish subsidiary was to handle manufacturing, and the new Bermudian entity was
responsible for the licensing of patents. Forest Laboratories Ireland paid the Bermudian firm a royalty fee for the
use of the patents and, since Bermuda does not have an income tax, this organizational structure reduced Forest
Laboratories Irelands tax rate to 2.4% from 10.3%. To further reduce Forests worldwide tax liabilities, the royalty
payment made to the Bermudian entity was paid to Forest Finance BV, a Dutch affiliate. By routing the royalty
through the Netherlands, Forest Laboratories Ireland avoided a 20% withholding tax that would be necessary if the
royalty was paid to an entity outside the EU (the Netherlands has no such withholding requirement). In the year of
the reorganization, foreign operations reduced Forests effective tax rate by 21.8%. More detail on how this
illustration relates to our measure of tax aggressiveness, as well as a further illustration based on Googles tax
planning strategies are provided in our Appendix 1.

environment. At the same time, managers (and shareholders) may have countervailing incentives
to provide limited disclosure regarding aggressive tax planning activities. In particular, although
US corporations are required to disclose details about material operations in other tax
jurisdictions, managers may be hesitant to transparently disclose the details of these subsidiaries
if doing so would provide a roadmap for an audit by the tax authorities. Hence, when aggressive
tax planning increases financial and organizational complexity, managers financial reporting
and disclosure choices may not serve to mitigate the increased opacity. Thus, we view the extent
to which aggressive tax planning reduces transparency to be an empirical issue.
Although the term tax planning is ubiquitous, we are aware of no universally accepted
definition of aggressive tax planning. Frank, Lynch, and Rego (2009 p. 468) define aggressive
tax reporting as, downward manipulation of taxable income through tax planning that may or
may not be considered fraudulent tax evasion. However, Slemrod (2004) argues that tax
aggressiveness is a broader set of transactions where the primary purpose is simply to lower the
firms tax liability.2 For our study, we define a tax aggressive firm as one that pays an unusually
low amount of tax given the firms industry and size. Our tax aggressiveness measure is based on
the notion that, other things equal, similar-sized firms in the same industry are expected to have
similar tax planning opportunities. And, among firms with similar tax planning opportunities,
firms with unusually lower tax liabilities can be considered more tax aggressive. As an
alternative measure of tax aggressiveness, we use the number of tax haven countries (as
defined in the literature) in which a firm has operations.
We document that tax aggressive firms are characterized by lower corporate
transparency. Specifically, we find that firms with unusually low tax liabilities have larger
2

This definition implies, for example, that investing in a tax-exempt bond or a sophisticated tax shelter are both
forms of tax aggressiveness (also see Hanlon and Heitzman, 2010).

analysts forecast errors, greater analysts forecast dispersion and a higher level of information
asymmetry as characterized by the adverse selection component of the bid-ask spread. Tax
aggressive firms also exhibit lower accruals quality, measured using several approaches
advanced in the earnings quality literature. Our tests control for a variety of expected
determinants of corporate transparency, including size, growth, risk, geographic concentration,
and book-tax gap (a commonly used proxy for earnings management activity in the tax
literature). In addition, our analysis is robust to several sensitivity analyses including a changes
specification, the treatment of loss-generating firms, alternative controls for geographic and
organizational concentration, and several alternative measures of tax aggressiveness (e.g.,
operations in tax haven countries, discretionary permanent tax differences and tax shelter
probabilities). Overall, our results suggest that the benefits of tax aggressiveness may come at a
cost of lower financial transparency.
We also investigate whether managers at tax aggressive firms recognize that tax planning
can give rise to transparency problems, and respond by augmenting their disclosures. Consistent
with this conjecture, we find that tax aggressive firms provide management discussion and
analysis sections of the 10-K report as well as conference calls that are, on average, lengthier and
contain more tax-related discussion. Further, we find some evidence that transparency problems
are lower when tax aggressive firms provide additional disclosures. These results run counter to
arguments in Desai and Dharmapala (2006) and Chen, Huang, Pereira, and Wang (2009) where
tax avoidance strategies are viewed as exacerbating agency conflicts between managers and

shareholders, and whereby managers may attempt to obfuscate tax strategies because they serve
to allow rent extraction that is detrimental to shareholders interests.3
Our results advance the literature on the relation between financial transparency and taxrelated decisions. It is well documented that differences between book and tax income provide
information to market participants (see Hanlon and Heitzman 2010). For example, Lev and
Nissim (2004) and Weber (2009) find that the ratio of taxable income to book income is useful in
predicting earnings growth, and Hanlon (2005) documents that extreme book-tax differences
provide a signal on the persistence of accruals. Further, when earnings management increases the
spread between book and tax income, the ability of accruals to provide information about future
cash flows can be constrained (e.g., Dhaliwal, Huber, Lee and Pincus, 2008 and Comprix,
Graham and Moore, 2010). These papers, however, do not investigate how aggressive tax
planning, irrespective of book-tax differences, alters the firms information environment. We
provide evidence that aggressive tax planning appears to reduce financial reporting transparency,
increase investor uncertainty about future profitability, and increase information asymmetry
between investors.
Overall, our findings highlight that costs associated with weak financial transparency
may serve as a constraint on aggressive tax planning. These results could help explain why some
firms appear to engage in more conservative tax planning than might otherwise be expected
given the potential tax savings.4 In addition, we develop new measures of tax aggressiveness
that incorporate the notion that corporate tax planning opportunities are expected to vary crosssectionally, and over time, as a function of a firms size and industry. Thus, our measures are
3

See also Desai, Dyck, and Zingales, 2007 and Hanlon, Hoopes, and Shroff, 2010 for additional discussions of how
tax planning may provide opportunities for insiders to extract rents.
4
See Weisbach (2002) for a discussion about how firms level of tax sheltering activity is surprisingly low given the
potential tax savings (a phenomenon called the under-sheltering puzzle).

constructed under an assumption that similarly-sized firms in the same industry face similar tax
planning opportunities. We recognize that the validity of this assumption is ultimately an
empirical issue, and in our tests, we give much consideration to potential sources of
measurement error and confounding sources of correlation between our tax aggressiveness
measure and our information variables of interest. These caveats aside, we expect that these tax
aggressiveness measures will be useful to future researchers investigating the relation between
tax aggressiveness and firm behavior.
The paper proceeds as follows. Section 2 provides a summary of prior literature and
develops our hypotheses on the relations between aggressive tax planning and financial reporting
transparency. Section 3 describes our sample selection procedures and descriptive statistics. We
present our results on the relation between tax aggressiveness and transparency, and whether tax
aggressive firms augment their disclosures in Section 4. Section 5 provides sensitivity analyses
and in Section 6, we conclude.

2.

Prior Research and Hypothesis Development

2.1. TRANSPARENCY COST OF AGGRESSIVE TAX PLANNING

In their seminal textbook, Scholes and Wolfson (1992) explain that managers face
conflicts between financial reporting and tax planning. While managers often desire to report
high levels of income to investors, they simultaneously desire to report low levels of income to
the tax authorities. In the U.S., as in many other countries, tax reporting rules differ from
financial reporting rules, allowing firms to report disparate levels of income to tax authorities

and to investors. However, as many economic transactions are reported similarly for book and
tax reporting, firms often face a trade-off between cash tax savings and lower reported earnings.5
Of course, reporting lower earnings is only one of many potential costs of tax planning.
Direct and indirect costs of tax planning include labor, information systems, coordination among
business units, expected audit costs and penalties when tax planning strategies are found to be
inappropriate, and potential tax-related agency conflicts between managers and shareholders.
A further potential cost, and the focus of our study, is the effect of tax planning on
corporate transparency. Poor transparency has been shown to impose an array of costs on firms,
such as raising both the debt and equity costs of capital, exacerbating governance problems, and
reducing investment efficiency (e.g., Leuz and Verrecchia, 2000; Beatty, Liao and Weber 2010;
Biddle and Hilary 2006). Many tax planning opportunities require the bifurcation of legal
structures into separate business activities (e.g., income that qualifies for treaty based
withholding taxes, activity qualifying for the domestic manufacturers deduction). As illustrated
in our multinational tax planning discussions of Google and Forest Laboratories in Appendix 1,
such tax planning strategies can also alter capital flows within a firm. We argue that if these
circuitous flows and separation of business activities make it more difficult for outsiders to
interpret the source and persistence of the firms earnings and cash flows, then this may reduce
the transparency of the firms financial and operating environment. Other examples of how tax
planning strategies can increase opacity include the creation of entities for multi-state tax
planning (e.g., captive REITs, intangible holding companies); net operating loss monetization;
capital loss utilization, and tax-motivated transfer pricing.

For example, see Scholes, Wilson and Wolfson (1990), Guenther, Maydew, and Nutter (1997); Maydew (1997);
Matsunaga, Shevlin, and Shores (1992).

Our research question is related to the call by Shackelford and Shevlin (2001) for further
research on the drivers of cross-sectional variation in tax planning. If reduced corporate
transparency is a cost of aggressive tax planning, and this cost varies cross-sectionally, then one
would expect to observe variation in tax planning across firms. Our study may also shed light on
the observation by Weisbach (2002) that aggressive tax planning appears to be underutilized by
firms given the large potential benefits and relatively small potential costs stemming from audits,
interest and penalties.6 Transparency-related costs may explain some of this apparent
underutilization of aggressive tax planning.
2.2. RELATION TO BOOK-TAX LITERATURE
Before moving on to our analysis, we note that our research question differs from
existing work on book-tax differences. Differences between book and tax reporting have been
used extensively to study the earnings quality of firms (e.g., Lev and Nissim 2004; Hanlon 2005;
Ayers, Jiang, and LaPlante 2009) and whether taxable income contains information incremental
to pre-tax income (e.g., Hanlon, LaPlante, and Shevlin, 2005; Hanlon, Maydew and Shevlin,
2008).7 Hanlon (2005) and Comprix et al. (2010) document that large book-tax differences are
associated with less persistent earnings and lower quality of accruals. In a similar vein, Dhaliwal

See also Armstrong, Blouin and Larcker (2012), Gallemore, Maydew and Thornock, (2013), Hanlon and
Heitzman, (2010).
7
These papers have led to what is known as the book-tax conformity. Many have argued that allowing firms to
report separate incomes for book and tax is precisely what leads to simultaneously aggressive tax and GAAP
reporting (e.g., Desai, 2005). If firms were forced to conform their book and tax reporting, then firms would be
relatively less incentivized to undertake earnings management or extreme tax planning. Economists propose that
firms should report their GAAP income on their tax returns (so, taxable income should confirm to book). Hanlon,
LaPlante, and Shevlin (2005) and Hanlon, Maydew, and Shevlin (2008) argue that conformity would result is the
loss of information to the capital markets. To date, the book-tax conformity debate continues with little consensus.
Although many in the academic community agree that conforming tax reporting and book reporting is not a good
idea (see Shackelford and Slemrod 2004), there is less agreement as to whether conformity ultimately leads to a loss
of information to the capital markets (e.g. Raedy, Seidman, and Shackelford, 2010; Atwood, Drake, and Myers,
2010).

et al. (2008) examines whether large book-tax differences are associated with a higher cost of
equity capital.
Within the existing book-tax difference literature, book-tax differences are considered
informative to the capital markets largely because they capture earnings management behaviour
as opposed to measuring tax planning activities.8 Our interest is in determining whether tax
planning itself can leave its imprint on corporate transparency. We conjecture that firms entering
into aggressive tax planning transactions potentially increase the opacity of their financial
reports, irrespective of managements choices regarding whether to bias reported earnings.
Consequently, we consider the possibility that firms are effectively trading off lower
transparency for cash tax benefits. All of our tests control for book-tax differences.
2.3. MEASURING AGGRESSIVE TAX PLANNING
Although some recent papers have begun to develop measures of tax aggressiveness,
each proxy has limitations, and as a result, no well-accepted measure of tax aggressiveness has
evolved in the literature. Wilson (2009) and Lisowsky (2010) create measures of the estimated
probability that a firm has entered into tax shelter. Both measures are derived by estimating a
probability from the coefficients of a logit model of attributes of firms discovered engaging in
shelter activity. These measures, however, rely on a very small sample of firms whose shelter
behavior was a) detected by the tax authorities and b) potentially litigated, and are therefore

For example, Blaylock, Shevlin and Wilson (2011) extend Hanlon (2005) to show that the lower earnings
persistence stems from large book-tax differences likely associated with higher income increasing earnings
management. Specifically (on page 3) the authors state We predict that in cases where large positive book-tax
differences arise primarily from extensive tax planning these differences do not signal managerial discretion over the
accruals process and, as a result, will not be associated with lower future earnings and accruals persistence. Hence,
the market appears to use book-tax differences to infer something about firms GAAP earnings process.

unlikely to be representative of the broad set of firms that engage in extensive tax planning.9
Frank, Lynch, and Rego (2009) develop a measure of discretionary permanent book-tax
differences, DTAX, which relies on the premise that permanent differences are more aggressive
than timing differences. Although anecdotal evidence suggests that the optimal tax planning
opportunity is one that creates permanent differences because of their financial statement
benefits, there is little evidence to support this conjecture (see Hanlon and Heitzman, 2010). De
Waegenaere, Sansing, and Wielhouwer (2010) provide a theoretical analysis suggesting that the
FIN 48 unrecognized tax benefit is the best financial-statement-generated measure of the level of
firm tax aggressiveness. However, their assertion is contingent on the quality of firms
compliance with the FIN 48 reporting regime (e.g., its usefulness as a measure of tax
aggressiveness would be eliminated if firms use the FIN 48 accrual to manage earnings, as
suggested by Hanlon and Heitzman, 2010). Another potential drawback to FIN 48 is that this
information is only available beginning in 2007. Finally, Lisowsky, Robinson, Schmidt (2010)
provide a continuum of the ability of specific measures of firms tax attributes to capture tax
aggressiveness. However, they do not empirically test whether their conjectures are correct.
Much of the work on tax planning is focused on understanding cross-sectional variation
in tax aggressiveness. For example, papers have found evidence that extreme tax planning is
associated with executive compensation and risk taking (e.g., Rego and Wilson 2010; Brown,
Drake, and Martin 2010). These papers, however, do not reach a consensus on how to measure
tax aggressiveness. Furthermore, we are unaware of measures that attempt to capture firms
aggregate level of tax aggressiveness. Although the shelter probabilities and DTAX are likely
9

Wilson (2009) relies on court records discussed in the popular press to identify his shelter firms. Lisowsky (2010),
which is an extension of Wilson (2009), identifies shelters using proprietary IRS data. His sample of shelter
transactions comes from the Office of Tax Shelter Analysis, which identifies shelters through the audit process.

correlated with aggressive tax planning, neither satisfactorily captures the full array of tax
planning activities. The shelter probabilities rely on detecting specific lawbreaking tax-related
transactions, and although such transactions are clearly aggressive, the shelter probability
measure does not capture many commonly employed legal tax planning efforts. Our objective is
to develop a measure of tax aggressiveness that includes both legal tax planning strategies as
well as inappropriate or grey tax shelter activity. Further, our intention is to study variation in
aggressive tax planning that stems from both timing and permanent differences, as opposed to
the DTAX measure which includes only aggressive permanent differences. Irrespective of our
concerns with these existing measures of tax aggressiveness, we provide evidence later in the
paper that some of our results are robust to using DTAX and tax shelter probabilities as
alternative proxies for tax aggressiveness.
In summary, although some proposed measures of aggressive tax planning exist, none
seems to encompass the aggregate level of tax aggressiveness of a particular firm. Existing
measures also fail to measure aggressiveness relative to a benchmark of a normal level of tax
planning. For example, some industries have far more extensive foreign operations than others
(computer manufacturing as compared to food distributers). These industries may well have
greater ability to take advantage of various tax planning strategies, but presumably investors or
analysts that follow these industries will be aware of such strategies. When investors and
analysts are aware of common industry practices, it seems plausible that such strategies do not
create substantial transparency problems.
We develop a tax aggressiveness measure that a) captures cross-sectional variation in
firms total tax planning (including timing and permanent differences), and b) benchmarks a
given firms tax aggressiveness relative to that of similar-sized firms in the same industry. We

10

construct our measure in two steps. First, we use the GAAP effective tax rate (GAAP ETR) as a
proxy for each firms aggregate tax burden. GAAP ETR is the total tax expense scaled by pre-tax
income.10 To reduce the influence of transitory year-to-year fluctuations in effective tax rates, we
estimate the effective tax rates by aggregating three years of data (as in Dyreng, Hanlon, and
Maydew 2008). GAAP ETR is therefore the sum of the past three years (t to t-2) of total tax
expense scaled by the sum of the past three years of pre-tax income. We then adjust each firms
three-year ETR by the same periods three-year ETR for the portfolio of firms in the same
quintile of total assets and the same industry, where size and industry are sorted independently
and industry is based on the 48 industries defined by Fama and French (1997). We therefore
measure tax aggressiveness, TA_GAAP, as the industry-size matched GAAP ETR less the firms
GAAP ETR. Positive values of TA_GAAP implies that the firm pays less tax than its size-industry
peers, and greater values for this measure suggest greater tax aggressiveness. We also construct a
second tax aggressiveness measure that is identical to TA_GAAP except that the effective tax rate
is estimated using total cash paid for income taxes rather than income tax expense. We refer to
the cash effective tax rate as the CASH ETR, and to this alternative tax aggressiveness measure
as TA_CASH. In Appendix 1, we discuss tax planning strategies at Google and Forest
Laboratories to illustrate of how our measure captures tax aggressiveness.
Because TA_GAAP and TA_CASH are bottom line measures that reflect the results of
aggressive tax planning, they are not constructed to identify specific tax planning strategies. As
noted above, strategic choices related to geographic operating and financing activities are one
common tax planning strategy for large corporations. As an alternative proxy for tax
aggressiveness, we examine the number of tax haven countries in which a firm reports that it
10

We truncate the GAAP ETR and Cash ETR to be between 0 and 1.

11

has a subsidiary. Tax havens are countries that are well known to offer firms tax advantages for
locating certain operating and financing activities within the countries borders. Hines and Rice
(1994) and Dyreng and Lindsay (2009) both provide evidence consistent with firms using tax
havens to reduce their tax obligations. We discuss the construction of our tax havens variable in
more detail in Section 5.
2.4. CORPORATE TRANSPARENCY MEASURES AND PREDICTIONS
If aggressive tax planning increases financial and organizational complexity, we predict
that tax aggressiveness will increase information uncertainty and information asymmetry, and
will reduce the quality of financial reporting (notwithstanding efforts by management to clarify
tax planning via augmented clarifying disclosures, an issue we discuss in more detail below).
Therefore, we construct measures of each of these three facets of transparency.
As proxies for information uncertainty, we use absolute analyst forecast errors (AFError)
and dispersion in analyst forecasts (AFDisp). We predict that aggressive tax planning will be
positively related to analyst forecast errors in absolute terms, and positively related to analyst
forecast dispersion. We measure AFError as the average absolute analyst forecast error over the
three years corresponding to the measurement of our tax aggressiveness measures (Gu and Wu
2003). Each year, the forecast errors are the absolute value of the difference between median
analyst estimate of forecasts issued immediately before the fiscal year-end and the actual
earnings for that fiscal year, scaled by the price at the end of previous year.

AFDisp is

computed as the three-year average of the standard deviation of the analysts forecasts issued
immediately before the fiscal year-end scaled by lagged price (we require at least five individual
analyst forecasts in the year to compute this measure).

12

We use the adverse selection component of the bid-ask spread as a proxy for information
asymmetry. This variable measures the extent to which prices are affected by unexpected order
flow and is increasing in the level of information asymmetry among investors. We estimate the
adverse selection component of the bid-ask spread, Spread, following Madhavan, Richardson,
and Roomans (1997) as described in Armstrong, Core, Taylor, and Verrecchia (2011) to take
into account cross-sectional differences in firm size.11 To estimate Spread, we gather trade-bytrade quote data from the ISSM and TAQ databases. We match trades and quotes using the Lee
and Ready (1991) algorithm with a five second lag to infer the direction of the trade (i.e., buy or
sell). Once trades are classified as either buyer- or seller-initiated, we estimate the following
firm-specific regression using all transactions available during the month:
pt/pt-1 = Dt + (Dt Dt-1) + ut

(1)

where pt is the transaction price, Dt is the sign of trade (+1 if buy and -1 if sell), and is the
AR(1) coefficient for Dt. We measure Spread () at a monthly level using all intra-day data for
that month to estimate equation (1) for each firm in the sample. We use the average over the
three years corresponding to the measurement of the tax aggressiveness measures in our tests.
We predict that aggressive tax planning is positively related to information asymmetry as
measured by Spread.
As a proxy for the quality of financial reporting, we use a measure of accruals quality
(AQ) that follows Francis et al. (2004, 2005) and is based on the measure developed by Dechow
and Dichev (2002). We construct the AQ measure by first estimating annual cross-sectional
regressions for each of the 48 Fama and French (1997) industries (at least 20 observations are
required for each industry-year regression):
11

This measure is sometimes referred to as lambda in the literature.

13

TCAi ,t = 0t + 1t

1
+ 2t CFOi ,t 1 + 3t CFOi ,t + 4t CFOi ,t +1 + 5t REVi ,t + 6t PPEi ,t + i ,t
ATAi ,t

(2)

where, for year t and firm i, TCA is total current accruals and is calculated as the
difference between net income and cash flow from operations, ATA is average total assets, CFO
is cash flow from operations, REV is the change in sales less the change in accounts
receivables, and PPE is property, plant and equipment. TCA, CFO, REV, and PPE are all scaled
by average total assets. The accruals quality measure is estimated for each firm i and each year t
as the standard deviation of residuals from the above cross-sectional regression over the period t5 to t-1.
We expect that if aggressive tax planning confounds the ability of accrual accounting to
resolve timing and matching problems with cash flows, then accruals quality will be lower.
Because the Dechow and Dichev (2002) measure is decreasing in accruals quality (i.e., a high
standard deviation of residual accruals implies a low quality accruals process), we expect that
aggressive tax planning will be positively related to the accruals quality measure.
2.5. CONTROL VARIABLES
We include controls for factors that are expected to influence the quality of a firms
information environment. To control for an expected positive relation between firm size and
transparency, we include Size, the log of market value of equity. We include Leverage, the ratio
of long-term debt to total assets, to control for firms debt service needs and capital structure, and
Age, the natural logarithm of the number of years the firm has been listed on Compustat, to
control for a relation between firm age and the quality of the information environment.
We control for geographic concentration using Bushman et al.s (2004) revenue-based
Hirfindahl-Hirschman index calculated as the sum of the squares of each geographic segments

14

sales as a percentage of the total firm sales. We anticipate that more geographically diverse firms
are relatively more opaque (note that lower values of the index imply a more diverse firm).
Controlling for geographic concentration helps ensure that our findings on tax aggressive are
incremental to any correlation between tax planning opportunities and the breadth of
international operations. We return to this issue in Section 5 where we consider other proxies for
geographic concentration.
To control for a relation between firms growth opportunities and transparency, we include
Mkt to Book, which is the ratio of the market value of assets to the book value of assets. We also
include an indicator variable, Loss, which is equal to one if the firms income before
extraordinary items is less than zero in the current year and zero otherwise. Loss firms typically
have lower earnings quality and have higher levels of information asymmetry. In addition, loss
firms can sometimes appear to be aggressive tax planners, when, in actuality, they merely have
very low income. The standard deviation of annual sales computed over the previous five years
(Std Dev of Sales) is included in all specifications as a control for operating volatility. Finally, we
include industry as well as year fixed effects in all specifications.
To ensure that our inferences regarding aggressive tax planning are not confounded by the
influence of book-tax differences, we include the absolute value of the mean of the past threeyears Book-Tax Gap, measured as pre-tax income less taxable income (defined as current
federal tax expense grossed up by the maximum federal statutory tax rate (i.e., 35%) plus pre-tax
foreign income less the annual change in NOLs) scaled by total assets. The book-tax gap has
been shown to be correlated with firms earnings management activities, and we include the
absolute value of the book-tax gap because earnings management, regardless of direction, could

15

affect earnings quality.12,13 Comprix et al (2010) and Dhaliwal et al. (2008) both provide
evidence that larger book-tax gaps adversely affect firms earnings quality and cost of equity
capital, respectively.
We also include control variables that are specific to certain specifications. In our Analyst
Forecast Error and Dispersion analyses, we include the log number of analysts following the
firm (Analyst Following). In our Spread analyses, we include several market based measures that
are known to explain variation in the bid-ask spread. The Std Deviation of Returns and the Std
Deviation of Volatility are included to capture expected volatility. Log Volume is included to
capture the liquidity of the security.

3. Sample
We obtain our data from the Compustat, CRSP, I/B/E/S, and NYSE TAQ databases for
the sample period 1990 through 2012. Constraining the sample to firms for which we are able to
compute our tax aggressiveness measures, as well as obtain analyst forecast error estimates, and
compute control variables results in our main sample of 35,708 firm-year observations.14 For our
financial reporting quality regressions, we further require the firms to have sufficient data to
compute accruals quality, thereby reducing the sample size to 32,246 firm-year observations. For

12

Because the market can surmise information about the firms tax position from their cash and GAAP effective
tax rates, it seems reasonable that little incremental information about the firms tax position can be gleaned from its
book-tax differences. Note that we are not saying that book-tax differences do not provide information about the gap
between book income and taxable income. Rather, consistent with Blaylock et al. (2011), we are arguing that any
market reaction to this difference stems from the signal about the quality of the firms GAAP earnings.
13
All of our inferences are identical if we use temporary book-tax differences (i.e., deferred tax expense grossed up
by 35%) or the signed book-tax gap, in place of the book-tax gap. All inferences also hold if we remove the booktax gap from the regression models.
14
We exclude REITs from our analysis as they are not typically subject to entity level taxation.

16

our bid-ask spread regressions, we require firms to have transaction-weighted bid-ask spread
data, further reducing the sample to 28,937 firm-year observations.15
The tests relating to management disclosure and tax havens require the extraction of text
from the MD&A and Exhibit 21 sections of each firms annual 10-K report, respectively. Exhibit
21 reports all of the firms material subsidiaries as well as their jurisdiction (typically the
subsidiaries location of incorporation). We obtain these data from SEC EDGAR. We were able
to extract and match MD&A data for 31,215 observations and Exhibit 21 data for 13,208
observations.16 Finally, our management disclosure tests also examine 3,679 observations
obtained from conference call transcripts in the Thomson Reuters StreetEvents database.
Table 1 presents descriptive statistics for our sample. The mean GAAP ETR and CASH
ETR of 30.0% and 25.1%, respectively, are lower than the 35% top statutory corporate tax rate,
which could be attributable to either extensive foreign operations and/or tax planning. The
standard deviations of these measures, 20% and 24% respectively, are quite high indicating
substantial cross-sectional variation in ETRs. The TA_GAAP and TA_CASH measures, which are
size-industry adjusted variables, exhibit nearly as much cross-sectional variation as do the raw
ETRs, indicating that substantial variation exists within industry and size groupings.17 With
respect to other firm characteristics, our sample is comprised of fairly large, mature, and
profitable firms (only 22.2% of firms report negative net income).

15

All of our key results are robust to, and in fact somewhat stronger, using the maximum number of observations
that are available for any given specification (i.e., robust to placing minimal restrictions on requiring a common
sample across the tables).
16
MD&A data is available from 1995. However, for Exhibit 21 we focused on the post-2001 10-K forms for ease
of extraction. Post-2001 companies filed 10-K using the XHTML format that enables easier identification of the
Exhibit.
17
Note that the means of our TA_GAAP and TA_CASH measures are not zero because we use all firms with
available ETR data to estimate three-year ETRs in the size-industry bins.

17

4. Results
4.1. THE RELATION BETWEEN TAX AGGRESSIVENESS AND TRANSPARENCY
We begin our analysis by examining the relation between aggressive tax planning and our
three types of financial transparency measures. Table 2 reports regressions of AFError and
AFDisp on our ETR-based proxies for tax aggressiveness. The regressions include controls for
both firm and earnings characteristics as discussed above. Consistent with our conjecture that
aggressive tax planning increases the difficulty faced by investors and analysts to forecast future
profitability, we find that absolute earnings forecast errors are significantly larger for firms with
low TA_GAAP and TA_CASH. In addition, we find that the dispersion of forecast errors is also
higher for tax aggressive firms. Consistent with analysts being less able to accurately forecast
earnings in the presence of managerial earnings management, we find that larger book-tax
differences are associated with higher forecast errors and greater forecast dispersion. With
respect to other control variables, we find that forecast errors and dispersion are greater for firms
that are smaller, more highly levered, and less geographically concentrated, and that have losses
and lower analyst following.
In Table 3, we examine whether aggressive tax planning is related to information
asymmetry between investors, as measured by the adverse selection component of the bid-ask
spreads. Our results indicate that the TA_GAAP and TA_CASH measures are positively
associated with Spread. Taken together with the results in Table 2, this finding suggests that
aggressive tax planning not only increases investor uncertainty about future profitability, but also
increases the information gap between informed and uninformed investors. Thus, it appears that
some investors have a relative advantage in obtaining or processing information about taxaggressive corporations.

18

Table 4 explores whether financial reporting transparency, as measured by accruals

quality (AQ), is adversely affected by aggressive tax planning. The findings indicate that
TA_GAAP and TA_CASH are positively related to AQ (recall that because AQ is the standard
deviation of residuals from the accruals regression model, greater values of AQ imply lower
quality accruals). We note that the Table 4 results are robust to using three alternative proxies for
accruals quality (i.e., a measure scaled by total current accruals, a measure estimated from
industry-size regression of accruals on cash flows, and a measure of AQ modified to give
consideration to opportunistic earnings management).18 The results in Table 4 indicate that,
controlling for book-tax differences and controls for firm characteristics, more aggressive tax
planning distorts the relation between accruals and cash flows.
A novel feature of our tax aggressiveness measures is the industry and size adjustment
made to firms ETRs to account for cross-sectional variation in tax planning opportunities. As
alternative tax aggressiveness measures, one could examine raw ETRs unadjusted for variation
in tax planning opportunities. To investigate whether our industry and size adjusted ETR
measure is incrementally informative about tax aggressiveness beyond simple raw ETR
measures, we partition firms into high and low TA_GAAP using an indicator variable set equal to
one when the firm is in the top half of the TA_GAAP distribution of tax aggressiveness, and zero
otherwise. We then re-run the regressions in Tables 2, 3 and 4, but replace TA_GAAP with the
raw GAAP ETR and the tax aggressiveness indicator variable. In untabulated results, we find that
even when the raw ETR variable is included in the regression, the tax aggressiveness indicator
18

Specifically, the three alternative accruals quality measures are as follows: 1) a scaled measure of accruals
quality calculated as AQ (from above) scaled by the mean absolute value of TCA over the period t-5 to t-1; 2) a
modified AQ measure that estimates the annual cross-sectional regression in equation (1) by industry and quintiles
of asset size to be consistent with the size and industry adjusted measurement procedure adopted for our tax
aggressiveness measure; and, 3) a modified version of AQ proposed by Wysocki (2008), who argues that the
accruals-based measure derived in Dechow and Dichev (2002) does not reliably capture high-quality accruals
because of a confounding relation with opportunistic earnings management.

19

variable is significantly related to all of the transparency proxies. We obtain similar results when
we use TA_CASH as the proxy for tax aggressiveness.
4.2. MANAGEMENT DISCLOSURE DECISIONS IN THE PRESENCE OF AGGRESSIVE TAX PLANNING
In light of our findings in Section 4.1., it is interesting to consider whether managers
augment disclosure to at least partially mitigate the difficulties investors have in understanding
the financial and organizational complexity induced by aggressive tax planning. The predictions
regarding augmented disclosure, however, are not unambiguous. On the one hand, shareholders
and other investors may demand increased disclosure to mitigate the reduced transparency
stemming from tax aggressiveness. On the other hand, managers may be reluctant to publicly
reveal too many details about their tax planning if this increases the likelihood that tax
authorities take action against the firm. Shareholders may also recognize these potential costs
and resign themselves to accept lower transparency in return for more profitable tax planning
activities.
In Table 5, Panel A, we explore whether managers who make aggressive tax planning
choices increase the volume of disclosure. We examine four proxies for volume of financial
disclosure: 1) the number of words in the Management Discussion & Analysis (MD&A) section
of the annual report (MDA); 2) the number of tax-related words in MDA (MDA_Tax)19; 3) the
total word length of conference call transcripts during the year (ConfCall), and; 4) the number of
tax-related words in conference call transcripts during the year (ConfCall_Tax).
After controlling for firm and industry characteristics (book-tax gap, size, leverage, age,
geographic concentration, market-to-book, losses, and sales volatility), we find that the four
19
Our tax-related search included the following terms: "captive REIT", passive, intercompany, offshore, transfer
prices(ing), tax (and any variation), shifting, intellectual property, intangible(s), withholding, royalty(ies),
management fee(s).

20

disclosure proxies are positively related to aggressive tax planning, as measured by TA_GAAP.20
Thus, the results in Table 5, Panel A suggest that management increases the volume of disclosure
in both the MD&A and via conference calls when the firm is more tax aggressive.
In Table 5, Panel B, we also explore whether firms that provide additional disclosure are
successful in reducing some of the transparency problems created by aggressive tax planning.
We expect that if additional disclosure mitigates tax-related transparency problems, the relation
between tax aggressiveness and analyst forecast errors will be less positive for high disclosure
firms than for low disclosure firms.
The results in Table 5, Panel B indicate that the relation between tax aggressiveness and
AFError is somewhat less positive for the high disclosure firms for each of the management
disclosure proxies.21 The difference between high and low disclosure firms, however, is only
significant for the conference call disclosure variable in Column (3). The results are similar if we
use AFDisp or Spread as the dependent variable (i.e., the differences between high and low
disclosure firms are significant in only a few cases). Overall, the results in Table 5, Panels A and
B suggest that managers supplement tax aggressiveness with increased disclosure, and that
increased disclosure may serve to mitigate at least some of the transparency problems that tax
aggressive operating strategies create. These results contrast with arguments in Desai and
Dharmapala (2006) and Chen, Huang, Pereira, and Wang (2009) where tax avoidance strategies
are viewed as exacerbating agency conflicts between managers and shareholders, and whereby
managers may attempt to obfuscate tax strategies because they serve to allow rent extraction that
is detrimental to shareholders interests.
20

The results are similar using TA_CASH as the proxy for tax aggressiveness.
We do not explore accounting quality as a dependent variable. Although the transparency problems created by
low accounting quality can be mitigated by augmented disclosure, accounting quality itself (as measured by the
relation between cash flows and accruals) is not directly altered by disclosure choices.
21

21

5. Sensitivity Analyses
5.1. ALTERNATIVE PROXIES FOR TAX AGGRESSIVENESS
Although we believe that our industry-size benchmarked measure of tax aggressiveness is
a constructive innovation to the tax planning literature, we appreciate the benefits of examining
the robustness of our results to alternative measures of tax planning. Therefore, we next explore
whether our results are robust to several alternative measures of tax planning aggressiveness. The
first alternative measure is based on whether firms have material subsidiary operations in
countries known to be tax havens. Firms use of haven countries for financial and operating
activities has been linked with evidence of extensive transfer pricing activity (Hines and Rice
1994) and lower effective tax rates (Dyreng and Lindsay 2009). We collect data on the number
of haven countries reported in firms Exhibit 21 in their 10-K. Exhibit 21 is a required element of
a firms 10-K and includes a listing of all of the firms subsidiaries with material operations.22
Tax havens are jurisdictions that structure a tax regime to take advantage of firms desire to
reduce their tax burdens. Generally, tax havens have low or no tax rates and have very little
information sharing of tax information with other jurisdictions thereby making it more difficult
for one jurisdiction to determine whether a firm is artificially stripping its earnings into the
haven. However, a haven could also include countries that have modified their tax laws to attract
foreign capital (e.g., Ireland). Either type of haven could be utilized for tax avoidance purposes.
Because there is no consensus on which countries are considered havens, we rely on two
sources to determine whether a country is a tax haven: (1) Table 1 in Dyreng and Lindsay
(2009), and; (2) the seven havens identified in Hines and Rice (1994).

TAX_HAVENS

22
See Rule 1-02(w) of Reg. S-X under the Securities Exchange Act of 1934 for a definition of a significant
subsidiary. Note that Exhibit 21 is only required to report where the subsidiary is incorporated, not where its assets
are located.

22

(TAX_HAVENS_BIG7) is the number of reported subsidiaries in Dyreng and Lindsays (Hines

and Rices) list of haven countries. Lists of the tax havens countries comprising these variables
are provided in Appendix 2, and include countries such as Bahamas, Cayman Islands, Hong
Kong, Netherlands, and Switzerland. Because havens are used for tax avoidance purposes, we
predict that greater haven usage is consistent with more aggressive tax planning. Within our
sample, the mean number of material operations in haven countries is 3.06 and 1.56 (see Table 1)
for TAX_HAVEN and TAX_HAVEN_BIG7, respectively. However, the median is zero for both
measures suggesting that havens are not used by the majority of firms.
In Table 6, we replicate the results in Tables 2, 3 and 4 using the tax haven measures of
tax aggressiveness in place of the ETR-based tax aggressiveness variables. The results are
similar to those in the earlier tables. Specifically, firms with operations in a greater number of tax
haven countries have larger absolute analyst forecast errors, greater forecast dispersion, and
larger bid-ask spreads. The haven measure does not appear to explain accruals quality. One
possible explanation for this latter result is that firms use of tax havens may frequently involve
financial activities as opposed to real economic activity, and the former may have relatively little
influence on the accrual process.
As discussed in Section 2.3., prior literature has also considered measures of tax
aggressiveness based on discretionary permanent tax differences (Frank et al.s, 2009, DTAX
variable) and the probability that the firm engaged in illegal tax shelters (Wilsons, 2009,
SHELTER variable). Although as noted above, we conjecture that these measures have some
weaknesses compared to our tax aggressiveness measure, we analyze these measures as further
alternative tax aggressiveness constructs.

23

Frank et al. (2009) compute DTAX as the residuals from a regression of an estimate of
permanent differences on measures of intangible assets, income of unconsolidated subsidiaries,
minority interest, state tax burdens, changes in NOLs, and lagged permanent differences.
Positive levels of DTAX indicate that our sample firms have discretionary permanent differences
that reduce taxable income relative to the population of Compustat firms that are used to estimate
DTAX. In untabulated tests, we find that greater tax aggressiveness, as measured by DTAX, is
associated only with higher spreads.
Wilson (2009) estimates SHELTER using a sample of approximately 60 firms identified
in court documents as having participated in illegal tax shelters. The probability that a firm is
engaging in a tax shelter is estimated as follows: SHELTER = - 4.86 + 5.20*BookTax Differences
+ 4.08*Discretionary Accruals - 1.41*Leverage + 0.76*Size + 3.51*ROA + 1.72*ForeignIncome
+ 2.42*R&D. In untabulated analysis, we find that tax aggressiveness, as measured by
SHELTER, is positively associated with analysts forecast errors, dispersion, and accounting
quality.23
5.2. CORRELATED OMITTED VARIABLES
A potential concern with our analysis is that tax aggressiveness may be correlated with
determinants of corporate transparency that are not adequately controlled for in our tests above.
Although it is difficult to rule out this possibility absolutely, we conduct two sets of robustness
tests to help address this concern. First, we conduct an alternative version of the analysis
reported in Tables 2, 3 and 4 in a changes specification. A changes specification can help
alleviate concerns about omitted variables by isolating a specific period of time over which
innovations in tax strategy are expected to cause a change in corporate transparency. Second, we
23

We note the possibility, however, that the relation between SHELTER and accounting quality could be
mechanical due to the fact that SHELTER and accruals quality are both a function of discretionary accruals.

24

control for several alternative measures of geographic diversification that help address a concern
that geographically complex organizations have access to a greater menu of tax reduction
strategies, and that such organizations also have more opaque information environments.
5.2.1 Changes analysis
Table 7 presents regressions analogous to those in Tables 2, 3, 4 and 5 (Panel A) but with
the dependent and independent variables measured in changes.24 The results show that increases
in tax aggressiveness are positively related to increases in analyst forecast errors and dispersion.
In the spread and accounting quality regressions, the coefficients on change in tax aggressiveness
are positive but not significant.25 We also find positive relations between tax aggressiveness and
all of the disclosure variables, although the coefficients are significant only for the MD&A
variables. One potential explanation for the insignificant coefficients in the conference calls
changes regressions could be the lack of power due to the reduction in sample size.
5.2.2 Alternative proxies for geographic concentration
Measuring the extent of firms geographic concentration is difficult because the concept
is somewhat abstract and the data from publicly available financial statements is coarse.
Measures of geographic concentration typically rely on segment data disclosed in firms 10-Ks.
Our analyses thus far use Bushman et al.s (2004) revenue-based Hirfindahl-Hirschman index
calculated as the sum of the squares of each geographic segments sales as a percentage of the
total firm sales (Geographic Concentration).

24

Note that because our main analyses in Tables 2, 3 and 4 are conducted using three-year average values for tax
aggressiveness and the transparency measures, the changes analysis examines changes in rolling three-year averages
for these variables.
25
In untabulated changes regressions using TA_CASH in place of TA_GAAP, we find that the change in tax
aggressiveness is significantly positively related to changes in spreads, as well as to changes in analyst forecast
errors and dispersion.

25

In Table 8, we re-estimate our Table 2 analyst forecast error regressions using four
additional measures of geographic concentration. In column (1), we measure concentration as an
asset-based Hirfindahl-Hirschman index, calculated as the sum of the squares of each geographic
segments assets as a percentage of the total assets (Geographic_Asset_Concentration). In
column (2), concentration is estimated using the number of geographic segments in which the
firm operates (Number of Geo Segments - note this measure is lower for geographicallyconcentrated firms). We also create a version of the Hirfindahl-Hirschman index,
BEA_Geo_Concentration, using affiliate information reported by firms to the Bureau of
Economic Analysis (BEA).26 When firms in the BEA data do not report any affiliate activity, we
assume that their foreign activity is immaterial and assign a 1 for the index. However, because
the BEA has minimum reporting thresholds, it is possible that assigning a value for missing
observations adds noise to the index. Therefore, we estimate two regressions using this BEA
measure: Column (3), where the regression is estimated using the entire sample of firms in the
BEA surveys, and Column (4), where the regression is estimated using only firms that report
foreign activity in the BEA surveys. Our fourth alternative measure of geographic diversity uses
Exhibit 21 10-K data on the number of countries and states where firms report material
subsidiaries. Column (5) reports results including two count measures of the number of unique
countries and the number of unique states in which the firm has material subsidiaries.
The results in Table 8 show that our previously documented relation between tax
aggressiveness and analyst forecast errors is robust to using any of these alternative measures of
26

We obtain the data for this measure from the Bureau of Economic Analysis (BEA) Survey of U.S. Direct
Investment Abroad. Participation in the BEA surveys is mandated by federal law pursuant to the International
Investment and Trade in Services Survey Act (P.L. 94-472, 90 Stat. 2059, 22 U.S.C. 3101-3108). The surveys
collect detailed financial information based on U.S. GAAP that is input and reviewed by BEA staff. These
procedures help reduce the limitations typically attributed to survey data. See Mataloni (2003) and
http://www.bea.gov/surveys/diadurv.htm for more detailed information on the BEA data.

26

geographic diversity.27 Further, although Table 8 only tabulates the robustness of our analyst
forecast error results to the alternative geographic diversity measures, our inferences with respect
to forecast dispersion, spreads, accounting quality, and management disclosure are also robust to
controlling for these alternative proxies for geographic diversity.28 As a final check on how our
results are influenced by geographic diversity, we partition our sample into high and low
international activity based on whether firms have greater than 50% of their sales or 50% of their
assets abroad. Our inferences hold in both the high and the low international activity partitions.
5.3. LOSS FIRMS
As a final robustness check, we examine whether our results are influenced by firms
reporting losses. Other things equal, loss firms typically have more opaque information
environments than profitable firms (Dechow and Dichev 2002). Although all of our analyses
include a dummy variable for firm years with a reported book loss, we undertake several
additional tests to allay potential concerns that loss firms are exerting undue influence on our
measures of tax aggressiveness.
In Table 9, we report the sensitivity of our analyst forecast error results to three
alternative specifications that consider the influence of loss firms on the results. In Column (1),
we limit our analyses to only the sample of firms that report positive estimated taxable income.
In Column (2), we again limit the sample to firms that report positive taxable income, but also
further restrict the sample to include only firms that have non-missing pre-tax foreign income
27

In untabulated tests, we also compare the average change in tax aggressiveness measures for firms that increase
the number of countries in which they operate with that of firms that continue to operate in the same number of
countries. We find the difference in the tax aggressiveness measures across these two groups of firms to be
insignificant, providing further evidence that the tax aggressiveness measure captures tax policy choice incremental
firms decisions to be geographically concentrated or diverse.
28
The one exception is that the accounting quality results are diminished in the regressions restricted to only those
firms reporting foreign activity in the BEA surveys. However, this may be due to reduced power stemming from a
much reduced sample size for the BEA survey data.

27

and positive estimated taxable income. This approach isolates the sample to those firms that have
the greatest opportunity to engage in foreign tax planning. Finally, in Column (3), we recompute
TA_GAAP by measuring a firms tax aggressiveness relative to industry-size benchmark firms
that have positive taxable income.
In each column of Table 9, we find that analysts forecast errors continue to be increasing
in tax aggressiveness. As in Table 8, for brevity, we have only tabulated the robustness of our
analysts forecast error results. However, the inferences from the sensitivity analyses in Table 9
also hold for our analyst forecast dispersion, information asymmetry, and accruals quality results
reported in Tables 2, 3 and 4.

6. Conclusion
Corporations engage in various forms of tax planning to reduce expected tax liabilities.
These expected benefits, however, do not come without costs. Such costs include direct labor
and information systems necessary to carry out the tax planning, as well as expected costs of
negotiation and penalties stemming from interactions with taxing authorities. In this paper, we
find evidence that a previously unexamined cost of tax planning, financial transparency, is
associated with the extent of a firms aggressive tax planning.
We specifically investigate whether aggressive tax planning reduces corporate
transparency. We develop a new measure of tax planning aggressiveness that benchmarks firms
tax burdens against firms of similar size and industry that are expected to have similar tax
planning opportunities. We also examine tax planning aggressiveness as a function of the
presence of subsidiaries in tax haven countries. Overall, our results suggest that as firms become
more tax aggressive, absolute analyst forecast errors, the dispersion of analysts forecasts and the

28

adverse selection component of the bid-ask spreads increase, while their accruals quality
decreases. However, managers appear to be aware of this potential cost, and aggressive tax
planning firms increase the volume of disclosure in the MD&A sections of their financial
statements as well as in conference calls. We also find some evidence that this increased
disclosure helps reduce the effect of aggressive tax planning on transparency.
Overall, our findings highlight lower financial transparency as a potentially important
cost of aggressive tax planning. These results may help explain why firms appear to engage in
more conservative tax planning that would otherwise be optimal.

29

APPENDIX 1
Examples
In this appendix, we provide two detailed examples of firms tax planning and how their
planning maps into our measures of tax aggressiveness.

Google
In 2005, Google appears to have transferred the licensing rights for its intellectual
property to Ireland. By shifting its valuable intangible rights to Ireland, Google effectively shifts
income out of the U.S. (where revenues used to all be paid) and into a more lightly taxed
jurisdiction. In Googles 2005 3rd Quarter 10-Q, Google states:
Our provision for income taxes increased to $408.7 million, or an
effective tax rate of 27% in the nine months ended September 30,
2005 The decrease in our effective tax rate was primarily
because proportionately more of our earnings in 2005 compared
to 2004 are expected to be recognized by our Irish subsidiary and
such earnings are taxed at a lower statutory tax rate than in the
U.S.
We expect our effective tax rate to be approximately 30% for
2005. However, if future earnings recognized by our Irish
subsidiary are not at the levels we expect, our effective tax rate
will be higher than our expectations.

However, evidence suggests that Google was still in the process of negotiating its transfer
pricing related to the licensing rights with the IRS into 2006 (see Drucker 2010b). During the 4th
quarter of 2005 (see their 8-K filed on January 31, 2006), Google determined that it had either
over-allocated income or under-allocated expenses to its Irish operations thereby whipsawing its
quarterly GAAP effective tax rate form 27% to 41.8%:
Our effective tax rate for the fourth quarter increased to 41.8%
this quarter, and to 31.6% for the year, above our previously
announced expectation of approximately 30% for the year.

30

Primarily because the proportion of total expenses allocated to

our international operations was greater than we anticipated,
more of our profits were taxed at a higher domestic tax rate;
this resulted in a greater effective tax rate compared to our
expectations. We expect our effective tax rate for 2006 to be
approximately 30%.

Google did not meet its fourth quarter 2005 earnings target. Although Google executives
attempted to explain that the unexpected increase in the effective tax rate was due to complex
tax matters, analysts appear to have presumed that Googles lower earnings was due to slower
than anticipated growth leading some to downgrade the stock:

"We're downgrading Google primarily because of concerns

about weaker-than-expected international revenue growth,"
said Ben Schachter, a UBS Securities analyst. "I think they
are investing heavily in that area, and that is the right thing
for the company in the long term. But in the near term, it will
put pressure on its margins for the next couple of quarters."

Another analyst reported the following on

(http://paul.kedrosky.com/archives/002512.html):

his

blog

after

the

conference

call

Why the tax rate was higher than expected -- Google doesn't
make that question easy to answer. Here is CFO George
Reyes doing obfuscatory tax-talk on the conference call:
[Tax rate] estimates are complex, and 2005 was the first year
we realized any reduction to our effective tax rate as a result
of profits earned overseas under our international structure.
At the end of the year, we must true up the tax provision for
the year, which could, and in the case of Q4, did have a
disproportionate impact on the fourth quarter.
In calculating our true-up for the year, a portion of expenses
allocated to international operations was greater than we
expected. Primarily as a result of this, a greater percentage
of our profits were taxed at a higher domestic tax rate, which
resulted in a greater effective tax rate compared to our
expectations.

31

Basically, Reyes is saying that Google spent more than it

planned to on its international business, and there wasn't
corresponding international revenue to match against it. As a
result, it had a higher percentage of its income in the U.S.,
and that meant a higher overall tax rate.
Okay, but why didn't international perform? I mean, Google
had to know it was "over-spending" internationally. Here's
Eric Schmidt's canned response to that question when asked
it twice on the call:
We think the opportunity ahead of us particularly in
international markets is just exceptional. And what you are
seeing is the investments that need to be made to sort of
harvest that opportunity.
Fair enough. Eric's basically saying "trust us", we're spending
madly on international markets, but we know what we're
doing. It's not a terrible answer, but it's also one that requires
more faith in a young public company than some people
might feel inclined to offer.
Overall, we conclude that there was significant confusion on the behalf of analysts regarding the
separation of the tax related issues from growth estimates. Note that the fact that Googles
GAAP effective tax rate was affected so severely in the 4th quarter is consistent with some
incremental cost allocation rather than a sudden drop in revenue. Furthermore, no evidence of
any drop in revenue growth can be gleaned from the 2005 financial statements.
Googles GAAP effective tax rate did drop from 38.6% in 2004 to 31,6% in 2005.
In 2006, Google must have ultimately negotiated a favorable transfer pricing agreement as its
effective tax rate dropped to 23.3%To provide some context for our tax aggressiveness measures,
we estimate Googles TA_GAAP and TA_CASH using the methodology described in Section 2.3.
We then scale all TA measures by the applicable size industry mean GAAP ETR and CASH ETR.
Scaling allows us to compare the measure across firms and over time. We then sort the scale

32

measures and ranked them by year into deciles (low deciles suggesting relatively more tax
aggressiveness).
Using this methodology, in 2004 Googles level of tax aggressiveness fell into decile 8
suggesting that it was relatively unaggressive. However, in 2005, it moved up to decile 5 and
then, in 2006, to decile 2 (for both TA_CASH and TA_GAAP). These rather large changes in
ranking imply a sizeable shift in the level of Googles tax planning. Google remained in decile 2
through 2009 (overlapping a period where Google undertook some significant foreign tax
planning as described in Drucker 2010b).

Forest Laboratories
Forest Labs has been identified as a firm that undertook the Double Irish and Dutch
Sandwich transaction during 2005/2006 as described in the introduction. Yet, Forest Labs
appears to have begun its extensive international tax planning agenda in fiscal year 2000. In its
2000 10-K, Forest reports net foreign revenue of $36.61 million but foreign pre-tax income of
$67.827 million. Compare these amounts to what was reported in its 1999 10-K: $37.044
million of revenues yielding $20.576 million in foreign pre-tax income. This large shift in pretax income without any corresponding change in revenues suggests the presence of significant
intercompany payments likely royalty payments attributable to the transfer of intellectual
property into Ireland.
Unfortunately, Forest Labs does not report an Exhibit 21 until 2004. In its 3/31/2004
Exhibit 21, it reports three foreign subsidiaries. After Forest Labs the tax planning described in
Drucker 2010a, it reports six foreign subsidiaries (2006 exhibit 21). This list includes the two
new Dutch subsidiaries created for the Dutch sandwich. Interestingly, there is no mention of any

33

Bermuda subsidiary. However, as the Exhibit 21 only requires firms to report the foreign
subsidiaries incorporation jurisdiction, the Bermuda activity must be included in one of its Irish
subsidiaries.
In terms of our measures of tax aggressiveness, following the methodology described in
the Google example, Forest Labs was in the 9th decile in 1999. Once it began its multinational
tax planning, it dropped all the way to decile 2 in 2000 and has remained in either decile 2 or 3
(for both TA_GAAP and TA_CASH) ever since.

34

APPENDIX 2
Variable Definitions
Tax Aggressiveness Measures (NOTE - Higher values imply more aggressive tax planning):

TA_CASHt: The firms mean industry size GAAP ETR less the firms GAAP ETR, where
GAAP_ETR is the sum of current tax expense over years t, t-1 and t-2 dividend by the sum of
pre-tax income over years t, t-1 and t-2.

TA_GAAPt: The firms mean industry size CASH ETR less the firms CASH ETR, where
CASH_ETR is the sum of cash paid for taxes over years t, t-1 and t-2 dividend by the sum of pretax income over years t, t-1 and t-2.

Tax Haven measures based on Exhibit 21 data from 10-Ks:

TAX_HAVENS: The number of times one of the following tax haven locations (as described in
Dyreng and Lindsay 2009) are mentioned in Exhibit 21of the current year 10K - ANDORRA,
ANGUILLA, ANTIQUA AND BARBUDA, ARUBA, BAHAMAS, BAHRAIN, BARBADOS,
BELIZE, BERMUDA, MOTSWANA, BRITISH VIRGIN ISLANDS, BRUNEI, CAPE VERDE,
CAYMAN ISLANDS, COOK ISLANDS, COSTA RICA, CYPRUS, DOMINICA,
GIBRALTAR, GRENADA, GUERNSEY AND ALDERNEY, HONG KONG, IRELAND, ISLE
OF MAN, JERSEY, KITTS AND NEVIS, LATVIA, LEBANON, LIBERIA,
LIECHTENSTEIN, LUXEMBOURG, MACAO. MACAU, MALDIVES, MALTA,
MARSHALL ISLANDS, MAURITIUS, MONACO, MONTSERRAT, NAURU,
NETHERLANDS ANTILLES (or DUTCH ANTILLES), NIUE, PALAU, PANAMA, SAMOA,
SAN MARINO, SEYCHELLES, SINGAPORE, ST. LUCIA, ST. VINCENT AND THE
GRENADINES, SWITZERLAND, U.S. VIRGIN ISLANDS, URUGUAY, VANUATU
TAX_HAVEN_BIG7: The number of times one of the following tax haven locations (as
described in Hines and Rice 1994) are mentioned in Exhibit 21 of the current year 10K - HONG
KONG, IRELAND, LEBANON, LIBERIA, PANAMA, SINGAPORE, SWITZERLAND

35

Information Environment Variables:

AFError: Absolute Analyst Forecast Errors measured as the average absolute analyst forecast
errors over the three years in which tax aggressiveness measures are calculated. Each year, the
forecast errors are the absolute value of the difference between median analyst estimate reported
immediately before the end of the fiscal year and the actual earnings for that fiscal year scaled by
the price at the end of previous year.

AFDisp: Average Dispersion of Analyst Earnings Forecasts measured as the three-year

average of the standard deviation of analysts annual earnings forecasts over the three years in
which tax aggressiveness measures are calculated. Each year, the dispersion in forecasts
immediately before the end of the fiscal year is scaled by the price at the end of previous year.
We require a minimum of five analyst forecasts each year to compute this measure.

Spread: A measure of information asymmetry and an estimate of the adverse selection

component of the bid-ask spread, computed based on Madhavan, Richardson, and Roomans
(1997) as modified by Armstrong, Core, Taylor, and Verrecchia (2010) to take into account
cross-sectional differences in firm size. We measure spread as the average monthly spread over
the three years in which tax aggressiveness measures are calculated.

AQ: Accruals Quality measured as the standard deviation of residuals over five-year rolling
window from an industry-year level Dechow-Dichev model augmented with fundamental
variables from Jones model (Francis et al . 2004, 2005). The variable is coded such that a lower
value of AQ means that the firm is more transparent.

Corporate Disclosure Variables:

MDA: Average number of words in the MD&A section of the annual 10-K report over the three
years in which tax aggressiveness measures are calculated.
MDA_Tax: the average number of tax-specific words in the MD&A section of the annual 10-K
report over the three years in which tax aggressiveness measures are calculated.
ConfCall: the number of words in the transcript of the conference call held by the management in
the year for which tax aggressiveness measures are calculated.
ConfCall_Tax: the number of tax-specific words in the transcript of the conference call held by
the management in the year for which tax aggressiveness measures are calculated.

Control Variables:

Book-Tax Gap: the absolute value of the average of years t, t-1 and t-2 book tax gap (defined as
pre-tax income less taxable income which is current federal tax expense grossed up by the
maximum federal statutory tax rate (i.e., 35%) plus pre-tax foreign income less the annual change
in NOLs /average of the last three years of total assets
Size: the log of market value of equity (in millions).
Leverage: the ratio of long term debt to total assets.
Age: the natural logarithm of the difference between the first year when the firm appears in
COMPUSTAT and the current year.

36

Geographic Concentration: a measure of multinational diversity of a firm. Following Bushman

et al (2004), this measure is a revenue-based Hirfindahl-Hirschman index, calculated as the sum
of the squares of each geographic segments sales as a percentage of the total firm sales.
Geo_Assets_Concentration: an assets-based Hirfindahl-Hirschman index, calculated as the sum
of the squares of each geographic segments assets as a percentage of the total firm assets.
Number of Geo Segments: the number of geographic segments in which the firm operates.
BEA_Geo_Concentration: a revenue-based Hirfindahl-Hirchman index created using affiliate
information reported by firms to the Bureau of Economic Analysis (BEA).
Mkt to Book: the market-to-book ratio measured as the ratio of the market value to the book
value of total assets.
Loss: an indicator variable that takes a value 1 if the firm has incurred a loss in the current year
and zero otherwise.
Analyst Following: the natural logarithm of the number of analyst estimates reported
immediately before the end of the fiscal year.
Std Dev of Sales: the standard deviation of annual sales over the previous five years.
Log Volume: the natural logarithm of the average monthly volume of stock traded over the three
year period over which the tax aggressiveness measures are estimated (in thousands).
Std Dev of Volume: the natural logarithm of standard deviation of monthly volume of stock
traded over the three year period over which the tax aggressiveness measures are estimated.
Std Dev of Returns: the natural logarithm standard deviation of monthly stock returns over the
three year period over which the tax aggressiveness measures are estimated.

37

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41

TABLE 1: Statistics
Descriptive statistics for the variables used in this study as defined in Appendix 2.

Variable

Mean

Std Dev

P25

Median

P75

GAAP_ETR

35708

0.300

0.195

0.187

0.342

0.388

CASH_ETR

35708

0.251

0.242

0.046

0.242

0.359

TA_GAAP

35708

-0.028

0.186

-0.105

-0.039

0.072

TA_CASH

35708

-0.012

0.213

-0.102

0.009

0.135

TAX_HAVENS

13208

3.189

9.853

0.000

0.000

3.000

TAX_HAVEN_BIG7

13208

1.615

4.940

0.000

0.000

1.000

AFError

35708

0.014

0.044

0.001

0.003

0.009

AFDisp

23933

0.003

0.007

0.001

0.001

0.003

Spread

28937

0.137

0.164

0.034

0.084

0.178

AQ

32246

0.056

0.048

0.024

0.041

0.071

MDA

31215

7383

5482

3423

6398

10198

23

23

16

34

MDA_Tax

31215

ConfCall

3679

30335

35874

7530

16644

37593

ConfCall_Tax

3679

17

Book-Tax Gap

35708

0.045

0.083

0.010

0.022

0.047

Size

35708

6.330

1.715

5.007

6.307

7.591

Leverage

35708

0.176

0.182

0.005

0.133

0.291

Mkt to Book

35708

1.764

1.023

1.071

1.392

2.063

Log Age

35708

2.736

0.720

2.197

2.639

3.332

Std Dev of Sales

35708

0.224

0.267

0.066

0.135

0.270

Geographic Concentration

35708

0.779

0.261

0.540

0.947

1.000

Loss

35708

0.222

0.416

0.000

0.000

0.000

Analyst Following

35708

1.882

0.791

1.099

1.946

2.485

Log Volume

28937

10.256

1.734

9.060

10.266

11.384

Std Dev of Returns

28937

0.123

0.059

0.081

0.112

0.153

Std Dev of Volume

28937

9.633

1.602

8.548

9.648

10.658

42

TABLE 2: Tax Aggressiveness and Absolute Analyst Forecast Errors and Dispersion
Pooled time-series cross-sectional regressions of analyst forecast errors (AFError) and dispersion of
analystfForecasts (AFDisp) on tax aggressiveness measures and control variables. All variables are defined in
Appendix 2. Industry and time effects are included in all specifications. t-statistics, reported in parentheses, are
calculated based on standard errors obtained by clustering at the firm as well as time level. Statistical significance
(two-sided) at the 10%, 5% and 1% level is denoted by *, **, and ***, respectively.

Predicted
Sign

(1)
AFError

TA_GAAP

0.019***
(9.123)

TA_CASH

Book-Tax Gap

Size

Leverage

Log Age

Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

Analyst Following

VARIABLES

Observations
R-squared

0.044***
(4.220)
-0.004***
(-7.567)
0.011***
(3.136)
0.004***
(4.555)
-0.006***
(-2.878)
0.000
(0.482)
0.017***
(10.067)
0.001
(0.913)
-0.007***
(-9.463)
0.019***

35,708
0.141

(2)
AFError

(3)
AFDisp

(4)
AFDisp

0.327***
(6.730)
0.016***
(9.275)
0.044***
(4.278)
-0.004***
(-7.328)
0.010***
(2.975)
0.004***
(4.655)
-0.007***
(-3.310)
-0.000
(-0.075)
0.017***
(10.416)
0.002
(1.040)
-0.007***
(-9.764)

35,708
0.141

0.624***
(3.060)
-0.050***
(-3.526)
0.404***
(4.789)
0.016
(0.908)
-0.055
(-1.204)
-0.034***
(-3.187)
0.334***
(10.429)
-0.017
(-0.560)
-0.066***
(-2.795)
0.327***

23,942
0.155

0.213***
(5.655)
0.658***
(3.214)
-0.049***
(-3.396)
0.403***
(4.785)
0.018
(0.978)
-0.072
(-1.591)
-0.037***
(-3.486)
0.346***
(10.928)
-0.018
(-0.594)
-0.067***
(-2.857)

23,942
0.152

43

TABLE 3: Tax Aggressiveness and Information Asymmetry

Pooled time-series cross-sectional regressions of information asymmetry (Spread) on tax aggressiveness measures
and control variables. All variables are defined in Appendix 2. Industry and time effects are included in all
specifications. t-statistics, reported in parentheses, are calculated based on standard errors obtained by clustering at
the firm as well as time level. Statistical significance (two-sided) at the 10%, 5% and 1% level is denoted by *, **,
and ***, respectively.

Predicted
Sign

(1)
Spread

TA_GAAP

0.015***
(3.041)

TA_CASH

Book-Tax Gap

Size

Leverage

Log Age

Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

Log Volume

Std Dev of Returns

Std Dev of Volume

VARIABLES

Observations
R-squared

0.003
(0.221)
-0.024***
(-9.219)
0.027**
(2.452)
0.002
(0.819)
-0.007
(-1.354)
0.004***
(2.818)
-0.002
(-0.653)
0.012**
(2.506)
-0.068***
(-10.455)
0.295***
(3.506)
0.035***
(6.372)
0.015***
28,937
0.463

(2)
Spread

0.019***
(3.286)
0.001
(0.091)
-0.024***
(-9.193)
0.026**
(2.366)
0.002
(0.924)
-0.008
(-1.498)
0.004***
(2.675)
-0.002
(-0.541)
0.012***
(2.612)
-0.068***
(-10.454)
0.293***
(3.499)
0.035***
(6.322)

28,937
0.463

44

TABLE 4: Tax Aggressiveness and Accruals Quality

Pooled time-series cross-sectional regressions of accruals quality (AQ) on tax aggressiveness measures and control
variables. All variables are defined in Appendix 2. Industry and time effects are included in all specifications. tstatistics, reported in parentheses, are calculated based on standard errors obtained by clustering at the firm as well
as time level. Statistical significance (two-sided) at the 10%, 5% and 1% level is denoted by *, **, and ***,
respectively.

Predicted
Sign

(1)
AQ

TA_GAAP

0.011***
(5.518)

TA_CASH

Book-Tax Gap

Size

Leverage

Log Age

Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

VARIABLES

Observations
R-squared

0.066***
(14.966)
-0.007***
(-18.467)
-0.003
(-1.378)
-0.002**
(-2.139)
-0.004**
(-2.240)
0.008***
(13.938)
0.003***
(3.765)
0.069***
(19.787)
0.011***
32,246
0.436

(2)
AQ

0.007***
(4.472)
0.067***
(15.334)
-0.007***
(-18.390)
-0.003
(-1.365)
-0.002**
(-2.124)
-0.005**
(-2.538)
0.008***
(13.718)
0.004***
(4.137)
0.069***
(19.703)

32,246
0.436

45

TABLE 5: Tax aggressiveness and Managements Disclosure

Panel A presents pooled time-series cross-sectional regressions of management disclosure proxies on tax aggressiveness
measures and control variables. In Column (1), disclosure is measured as the length of the Management, Discussion &
Analysis (MD&A) section of firms 10-K reports (MDA). In Column (2), disclosure is measured as the number of taxspecific words in the MD&A section of firms 10-K reports (MDA_Tax). In Column (3), disclosure is measured as the
word length of conference call transcripts held by the management during the year (ConfCall). In Column (4), disclosure is
measured as the number of tax-specific words in conference call transcripts held by the management during the year
(ConfCall_Tax). Panel B examines whether the relation between tax aggressiveness and analyst forecast errors differs
between high disclosure firms and low disclosure firms. TA_GAAP_HI_DISC that takes the value TA_GAAP if the value of
the disclosure variable is above median and zero otherwise. TA_GAAP_LO_DISC takes the value TA_GAAP if the value of
the disclosure variable is below median and zero otherwise. All other variables are defined in Appendix 2. Industry and
time effects are included in all specifications. t-statistics, reported in parentheses, are calculated based on standard errors
obtained by clustering at the firm as well as time level. Statistical significance (two-sided) at the 10%, 5% and 1% level is
denoted by *, **, and ***, respectively.

Panel A: Regressions of Disclosure Proxies on Tax Aggressiveness

Predicted
Sign

(1)
MDA

(2)
MDA_Tax

(3)
ConfCall

(4)
ConfCall_Tax

TA_GAAP

Book-Tax Gap

Size

Leverage

Age

Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

1.348***
(6.608)
1.770***
(3.890)
0.740***
(13.470)
1.722***
(4.901)
-0.664***
(-6.008)
-1.631***
(-6.072)
-0.655***
(-9.850)
1.001***
(11.957)
0.406***
(3.375)

0.003***
(3.270)
-0.003**
(-2.002)
0.002***
(7.972)
0.002
(1.562)
-0.002***
(-3.620)
-0.013***
(-6.978)
-0.002***
(-8.738)
0.001***
(3.511)
-0.001
(-0.833)

8.801**
(2.555)
12.287**
(2.383)
9.896***
(7.728)
-4.402
(-1.222)
9.267***
(6.164)
-5.073
(-1.271)
-0.694
(-0.631)
4.559***
(3.402)
5.328**
(2.470)

0.004***
(2.859)
0.001
(0.206)
0.002***
(5.520)
0.003
(1.477)
0.002**
(2.273)
-0.002
(-0.820)
-0.000
(-0.700)
-0.000
(-0.096)
0.001
(0.787)

31,215
0.310

31,215
0.344

3679
0.271

3679
0.173

VARIABLES

Observations
R-squared

46

Panel B: Does High Disclosure Mitigate Effect of Tax Aggressiveness on Analyst Forecast Errors?

VARIABLES
DISCLOSURE MEASURE

Predicted
Sign

TA_GAAP_HI_DISC

TA_GAAP_LO_DISC

Difference
t-stat

(1)
AFError

(2)
AFError

(3)
AFError

(4)
AFError

MDA

MDA_Tax

ConfCall

ConfCall_Tax

0.016***
(5.102)
0.019***
(5.783)

0.016***
(5.876)
0.020***
(2.819)

0.003
(0.444)
0.010***
(2.753)

0.001
(0.144)
0.006*
(1.728)

-0.003
(-0.850)

-0.005
(-1.413)

-0.123***
(-3.094)

-0.005
(-0.616)

0.030***
(4.577)
-0.004***
(-6.332)
0.007**
(2.412)
0.004***
(4.762)
-0.005**
(-2.223)
0.000
(0.964)
0.012***
(8.712)
0.004**
(2.132)
-0.006***
(-5.963)

0.030***
(4.565)
-0.004***
(-6.294)
0.007**
(2.378)
0.004***
(4.794)
-0.005**
(-2.216)
0.000
(0.956)
0.012***
(8.687)
0.004**
(2.133)
-0.006***
(-5.948)

-0.001
(-0.345)
-0.003**
(-2.397)
0.007
(1.104)
0.004**
(2.153)
0.001
(0.258)
-0.001
(-1.191)
0.008***
(2.805)
0.001
(0.354)
-0.003
(-1.545)

-0.002
(-0.434)
-0.003**
(-2.377)
0.007
(1.195)
0.004**
(2.189)
0.001
(0.264)
-0.001
(-1.088)
0.008***
(2.773)
0.001
(0.339)
-0.002
(-1.529)

21,972
0.129

21,972
0.130

3340
0.109

3340
0.108

Control Variables:
Book-Tax Gap

Size

Leverage

Log Age

Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

Analyst Following

Observations
R-squared

47

TABLE 6: Tax Havens Measure of Tax Planning Aggressiveness

Regressions similar to those reported in Tables 2, 3 and 4, but using TAX_HAVENS and TAX_HAVENS_BIG7 as the proxies for aggressiveness tax planning.
TAX_HAVENS and TAX_HAVENS_BIG7 are computed from 10-K Exhibit 21 reporting on the country breakdown of firms operations. All variables are defined
in Appendix 2. Industry and time effects are included in all specifications. t-statistics in parentheses are calculated based on standard errors obtained by clustering
at the firm and time level. Statistical significance (two-sided) at the 10%, 5% and 1% level is denoted by *, **, and ***, respectively.
Predicted
(7)
(8)
(1)
(2)
(3)
(4)
(5)
(6)
Sign
AQ
AQ
VARIABLES
AFError
AFError
AFDisp
AFDisp
Spread
Spread
TAX_HAVENS

TAX_HAVEN_BIG7

Book-Tax Gap

Size

Leverage

Log Age

Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

Analyst Following

Log Volume

Std Dev of Returns

Std Dev of Volume

Observations
R-squared

0.291**
(2.557)

0.032***
(4.301)
-0.003***
(-4.867)
0.004
(1.297)
0.003***
(3.309)
-0.003
(-1.246)
0.000
(0.039)
0.010***
(7.957)
0.004**
(2.211)
-0.005***
(-5.663)

13,208
0.115

2.649
(1.369)
0.563***
(2.854)
0.032***
(4.289)
-0.003***
(-4.889)
0.004
(1.293)
0.003***
(3.301)
-0.002
(-1.185)
-0.000
(-0.026)
0.010***
(7.942)
0.005**
(2.254)
-0.005***
(-5.690)

13,208
0.115

0.456***
(2.721)
-0.008
(-0.579)
0.321***
(4.698)
0.008
(0.469)
-0.047
(-1.092)
-0.025***
(-3.492)
0.252***
(6.222)
0.055
(1.508)
-0.078***
(-2.915)

9,727
0.142

1.820***
(4.927)
5.161
(1.431)
0.455***
(2.714)
-0.008
(-0.560)
0.321***
(4.703)
0.008
(0.471)
-0.047
(-1.063)
-0.025***
(-3.576)
0.252***
(6.241)
0.056
(1.542)
-0.077***
(-2.909)

9,727
0.142

0.115
(1.105)

0.003
(0.184)
-0.015***
(-3.081)
-0.002
(-0.163)
0.010***
(3.222)
0.002
(0.440)
0.004*
(1.907)
-0.003
(-1.446)
0.008
(1.284)

2.971***
(4.645)
0.003
(0.178)
-0.015***
(-3.037)
-0.002
(-0.190)
0.010***
(3.363)
0.002
(0.310)
0.004*
(1.778)
-0.003
(-1.393)
0.008
(1.370)

-0.068***
(-8.006)
0.256***
(4.073)
0.045***
(7.704)

-0.068***
(-7.973)
0.253***
(4.028)
0.046***
(7.701)

10,160
0.428

10,160
0.426

0.064***
(9.564)
-0.007***
(-12.392)
-0.004
(-1.108)
-0.001
(-1.125)
-0.003
(-1.055)
0.007***
(7.542)
0.003**
(2.161)
0.064***
(13.021)

0.318
(1.595)
0.064***
(9.563)
-0.007***
(-12.553)
-0.004
(-1.131)
-0.001
(-1.147)
-0.003
(-0.926)
0.007***
(7.586)
0.003**
(2.136)
0.064***
(13.035)

11,270
0.384

11,270
0.385

48

TABLE 7: Changes Analysis

This table re-estimates the regressions reported in Table 2,3 and 4 but using a changes framework. All variables are defined in Appendix 2. The prefix D_ refers
to the changes in the variable. Time effects are included in all specifications. t-statistics, reported in parentheses, are calculated based on standard errors obtained
by clustering at the firm as well as time level. Statistical significance (two-sided) at the 10%, 5% and 1% level is denoted by *, **, and ***, respectively.

VARIABLES

Predicted
Sign

D_TA_GAAP

D_Book-Tax Gap

D_Size

D_Leverage

D_Geo Concen

D_Mkt to Book

D_Loss

D_Std Dev of Sales

D_Analyst Following

D_Log Volume

D_Std Dev of Return

D_Std Dev of Volume

Observations
R-squared

(1)
(2)
D_AFError D_AFDisp

(3)
D_Spread

(4)
D_AQ

(5)
D_MDA

(6)
D_MDA_Tax

(7)
D_ConfCall

(8)
D_ConfCall_Tax

0.174**
(2.551)
2.279***
(3.403)
-0.525***
(-5.569)
0.249
(1.041)
-0.058
(-0.173)
0.286***
(6.225)
0.274***
(4.860)
-0.669***
(-3.133)
-0.451***
(-7.794)

0.001
(0.920)
0.019***
(3.903)
-0.011***
(-6.051)
-0.002
(-0.423)
-0.001
(-0.174)
0.004***
(6.251)
-0.003***
(-3.794)
-0.000
(-0.008)

0.102*
(1.645)
0.847***
(3.981)
-0.067
(-1.425)
0.100
(0.856)
0.478*
(1.906)
0.049
(1.568)
-0.207***
(-6.017)
2.711***
(11.582)

0.165
(1.402)
0.627**
(2.568)
-0.081
(-1.065)
0.722**
(2.477)
0.060
(0.145)
-0.033
(-0.739)
-0.045
(-0.877)
0.152
(0.411)

0.159***
(2.762)
0.070
(0.862)
0.009
(0.246)
0.115
(0.964)
-0.098
(-0.523)
-0.028*
(-1.714)
-0.005
(-0.198)
-0.205*
(-1.859)

2.182
(0.913)
-3.909
(-0.357)
-2.216*
(-1.850)
0.961
(0.145)
-2.671
(-0.599)
2.635**
(2.574)
-2.003*
(-1.748)
0.431
(0.063)

0.001*
(1.704)
-0.001
(-0.467)
0.000
(0.716)
-0.002
(-0.950)
-0.003
(-0.756)
0.000
(0.039)
-0.000
(-0.415)
-0.004*
(-1.797)

26,027
0.020

22,556
0.028

22,556
0.014

2,017
0.044

2,017
0.023

0.012*
(1.789)
0.081*
(1.720)
-0.037***
(-5.487)
0.075***
(3.316)
-0.032*
(-1.668)
0.015***
(4.695)
0.015***
(3.684)
-0.025
(-1.191)
-0.029***
(-4.454)

-0.083***
(-15.302)
0.398***
(9.419)
0.019***
(11.031)
28,062
0.029

18,852
0.026

21,832
0.186

49

TABLE 8: Alternative Measures of Geographic Concentration

Regressions similar to those reported in Table 2 but controlling for alternative measures of geographic concentration.
Geo_Assets_Concentration is measured as an asset-based Hirfindahl-Hirschman index, calculated as the sum of the
squares of each geographic segments assets as a percentage of the total assets. Number of Geo Segments measures the
number of geographic segments in which the firm operates. BEA_Geo_Concentration is the revenue-based HirfindahlHirchman index created using affiliate information reported by firms to the Bureau of Economic Analysis (BEA).
Countries (States) is the number of countries (states) where firms report material subsidiaries. All other variables are
defined in Appendix 2. Industry and time effects are included in all specifications. t-statistics, reported in parentheses,
are calculated based on standard errors obtained by clustering at the firm as well as time level. Statistical significance
(two-sided) at the 10%, 5% and 1% level is denoted by *, **, and ***, respectively.
Predicted
Sign

(1)
AFError

(2)
AFError

(3)
AFError
(BEA
restricted
sample)

(4)
AFError
(BEA
restricted
sample foreign
activity only )

(5)
AFError

TA_GAAP

0.021***
(9.610)

0.020***

0.017***
(6.241)

0.015***
(5.483)

0.012***
(4.459)

Book-Tax Gap

Size

Leverage

Age

0.056***
(5.182)
-0.002***
(-4.536)
0.017***
(3.476)
0.003***
(2.785)

0.042***
(3.408)
-0.003***
(-4.542)
0.014**
(2.115)
0.001
(1.176)

0.028***
(3.547)
-0.004***
(-5.653)
0.008**
(2.478)
0.004***
(4.279)

Geo_Assets_Concentration

0.047***
(4.920)
-0.004***
(-7.065)
0.010***
(3.296)
0.004***
(5.131)
-0.002
(-1.299)

Number of Geo Segments

BEA_Geo_Concentration

-0.001
(-1.075)

-0.007*
(-1.854)

Countries

States

Mkt to Book

Loss

Std Dev of Sales

Analyst Following

VARIABLES

Observations
R-squared

(9.558)
0.048***
(4.947)
-0.004***
(-7.189)
0.010***
(3.331)
0.004***
(5.224)

0.001**
(2.456)

0.000
(0.559)
0.020***
(10.852)
0.002
(1.010)
-0.007***
(-8.644)

0.000
(0.642)
0.020***
(10.813)
0.002
(1.008)
-0.007***
(-8.685)

-0.000
(-0.778)
0.015***
(7.608)
0.007***
(2.625)
-0.007***
(-9.666)

(-0.373)
0.011***
(5.468)
0.007*
(1.649)
-0.006***
(-6.700)
(-0.373)

0.055***
(3.284)
0.008
(0.958)
0.001*
(1.741)
0.014***
(6.497)
0.004**
(2.207)
-0.004***
(-3.687)

35,708
0.144

35,708
0.144

21996
0.167

10900
0.146

14210
0.142

50

TABLE 9: Sensitivity Analysis Restricted to Positive Taxable Income Firms

This table re-estimates the regressions reported in Table 2 but using three alternate specifications that consider the
influence of loss firms on the results. Column (1) restricts the sample to firms with aggregate positive taxable
income over years t, t-1and t-2. Column (2) restricts the sample to firms with positive taxable income as well as
firms having foreign income (since foreign income firms are more likely to have opportunities to engage in foreign
tax planning. Column (3) restricts the sample to firms with positive taxable income, and also re-computes the
TA_GAAP variable by measuring a firms tax aggressiveness relative to industry-size benchmark firms that have
positive taxable income. Industry and time effects are included in all specifications. t-statistics, reported in
parentheses, are calculated based on standard errors obtained by clustering at the firm as well as time level.
Statistical significance (two-sided) at the 10%, 5% and 1% level is denoted by *, **, and ***, respectively.

Restricted sample: Positive taxable income firms only

No additional
restrictions
Predicted
Sign

(1)
AFError

Further restriction:
Foreign income
firms only
(2)
AFError

TA_GAAP

0.013***
(7.720)

0.008***
(5.553)

0.011***
(7.485)

Book-Tax Gap

Size

Leverage

0.054***
(4.204)
-0.003***
(-6.136)
0.012***
(3.256)
0.002***
(3.591)
-0.006***
(-2.967)
-0.000
(-0.389)
0.015***
(9.165)
0.000
(0.333)
-0.006***
(-8.892)

0.053***
(4.374)
-0.002***
(-3.764)
0.011**
(2.467)
0.002*
(1.908)
-0.004*
(-1.896)
-0.000
(-0.659)
0.010***
(5.298)
0.001
(0.596)
-0.005***
(-6.934)

0.058***
(4.304)
-0.003***
(-6.349)
0.009***
(2.819)
0.002***
(2.711)
-0.005***
(-3.141)
-0.000
(-1.388)
0.012***
(7.779)
-0.000
(-0.034)
-0.005***
(-9.893)

28,318
0.126

16,342
0.107

27,592
0.107

VARIABLES

Age
Geographic Concentration

Mkt to Book

Loss

Std Dev of Sales

Analyst Following

Observations
R-squared

Tax aggressiveness
computed relative to positive
income control firms
(3)
AFError

51