Developing tax-avoidance strategies could assist firms in balancing risks and rewards 

A new study by a team including Texas A&M Mays Business School researcher uncovered the intricate link between tax strategies and risk factors for firms. The study by Brian Williams, professor in the James Benjamin Department of Accounting, and colleagues was recently published in The Accounting Review.  

The study explores how tax avoidance influences two distinct types of firm risk: priced risk, the associated with economic shocks that are undiversifiable, and idiosyncratic risk, the risk unique to a firm’s operations. Using a latent class mixture model, the researchers analyzed subsamples of firms exhibiting different relations between tax avoidance and these risks. 

Results of analysis found that on average, tax avoidance is negatively related to both priced risk and idiosyncratic risk. This suggests that, in many cases, tax avoidance strategies do not significantly increase a firm’s exposure to market-wide or unique operational risks. 

However, the study uncovered significant heterogeneities across different subsamples of firms. A notable proportion of the sample exhibits a positive association between tax avoidance and both types of risk. This subset of firms often employs more aggressive and uncertain tax strategies, has extensive foreign operations, holds more intangible assets, faces lower operating risks and has higher managerial incentives for risk-taking. 

For these firms, tax avoidance strategies contribute to a heightened exposure to undiversifiable economic shocks and a higher covariance of their cash flows with market cash flows, leading to increased priced risk. Additionally, these strategies amplify tax uncertainty and operational complexity, thereby elevating idiosyncratic risk. 

Overall, the findings reveal that tax avoidance can be an effective tool for reducing tax liabilities, but it also has the potential to increase a firm’s exposure to certain risks. The study suggests that a balanced approach to tax planning, where the benefits of tax avoidance are weighed against the potential increase in both priced and idiosyncratic risk could be beneficial to firms.