Firm valuation and the uncertainty of future tax avoidance

Abstract

The paper studies the effect of uncertainty in tax avoidance on firm value. We first show in a clean surplus valuation model that expected tax rates interact with expectations about future profitability. This paper builds and tests a valuation framework that incorporates two outcome dimensions of corporate tax avoidance strategies: the stability and the level of expected tax rates. We develop a tax planning score that captures these two dimensions. The measure improves the prediction of future tax avoidance. We finally show that the tax planning score strengthens the effect of pre-tax earnings on firm value. Firms with effective and persistent tax planning have a stronger effect of pre-tax earnings on firm value while firms with poor tax planning or volatile effective tax rates receive a discount on their earnings