Industry Tax Planning and Stock Returns

Abstract

We investigate whether industry tax planning affects a firm’s cost of capital by increasing its exposure to tax policy risk. We find evidence that equity returns increase with the propensity for tax planning in a firm’s industry. Consistent with a policy risk interpretation, the magnitude of the identified premium becomes stronger during periods of high Democratic influence over the White House and the United States Tax Court. This risk premium is imposed on all firms in the industry, even those that are less aggressive than their industry peers, which is consistent with the existence of an industry-wide externality. The industry-based risk premium coexists with a firm-specific risk discount associated with active tax planning strategies with low systematic risk. This individual firm effect, however, is dwarfed by the industry-based risk premium and is concentrated in industries that are less likely to attract scrutiny from the tax authority.

Keywords: Tax Planning, Tax Avoidance, Policy Risk, Asset Pricing

JEL Classification: G12, H25, H26, E62, G38, M40