Does Paying More Taxes Mean Less Volatile Stock Returns?

ABSTRACT Paying more corporate taxes may signal tax compliance. An alternative view suggests that corporations that pay more taxes are less efficient in designing their tax strategies than those that pay less taxes. Therefore, firms may adopt tax‐saving strategies. The problem arises when firms become too aggressive and embark upon the gray zone, where there is no clear distinction between tax saving and tax avoidance/evasion. We provide empirical evidence that tax aggressiveness causes an increase in firm‐specific risk. This effect is more pronounced for opaque firms, but it is not sensitive to the quality of corporate governance. It does not differ between multinational and domestic firms, or between firms that borrow money from the foreign debt market and those that do not. Additionally, we find that tax aggressiveness is positively related to higher levels of earnings volatility, stock price crash risk, total risk, and systematic risk. The relationship between tax aggressiveness and idiosyncratic volatility is unaffected by managerial incentives, past investment behavior, ESG performance, or innovation intensity.