Tax avoidance and future profitability
Coauthor(s): Sharon Katz, Andy Schmidt.
Do firm managers invest the savings from tax avoidance in positive net present value projects
that enhance future profitability or divert them towards perquisite consumption, rent extraction,
and value destroying projects? We indirectly investigate this question by testing whether tax
avoidance moderates the association between current and future profitability. Consistent with the
negative implications of tax avoidance (e.g. rent extraction) we document that, on average, the
main components of current profitability: margins, utilization of assets and operating liability
leverage, result in lower future profitability for tax aggressive firms as compared to firms that are
not tax aggressive. Further, the negative effect of lower margins is more robust and persistent
than the impact of inefficient asset utilization and operating liability leverage. These results
persist in various contexts that mitigate or exacerbate rent extraction, such as the existence of
foreign operations, better governance structure, more transparency, industry leadership position,
and across corporate life cycle stages.
Katz, Sharon, Urooj Khan, and Andy Schmidt. "Tax avoidance and future profitability." Columbia Business School, 2013.