Does a Firm’s Business Strategy Influence its Level of Tax Avoidance?

Abstract

A firm’s business-level strategy dictates how the firm competes in its chosen line of business. Porter (1996) argues that the best way for a firm to achieve a sustainable competitive advantage in its chosen market is to reinforce its business-level strategy with a host of activities, including functional policies, organization structure, etc. The choices made by each firm are likely to determine, to some extent, the level of tax avoidance because the firm strategies are, in part, based on firms’ willingness to deal with risk and uncertainty. Thus, we examine whether a firm’s business strategy, as defined by the Miles and Snow typology (1978), influences its level of tax avoidance. We find that firms engaging in a strategy that focuses on minimizing and reducing the uncertainty of costs (defenders) avoid fewer taxes than firms that not only follow a strategy focusing on product differentiation and the aggressive pursuit of opportunities, but are more willing to deal with uncertainty (prospectors). Our results suggest that even though defenders could engage in tax avoidance activities to lower costs, prospectors are more willing to engage in tax planning efforts that have uncertain outcomes.