How Do Firms Assess the Risks of Tax Aggressiveness? Evidence from Mandated Enterprise Risk Assessments

Abstract

Tax aggressiveness can affect cash flow for various non-tax reasons, such as diminished reputation or investments in high-risk locations. These risks likely require information beyond the accounting function’s expertise to fully evaluate. Using a novel regulatory setting in the U.S. insurance industry, I examine whether the staggered adoption of mandated enterprise risk assessments update managers’ prior beliefs about the non-tax risks of tax aggressiveness. I find that the assessment of firm-wide risks and their interdependencies leads to a reduction in tax aggressiveness. Reduced tax aggressiveness is concentrated within firms that appear to update their overall firm risk assessment the most in response to the regulatory requirement. The reduction to tax aggressiveness is also larger when managers have lower risk-taking incentives (vega). Together, results suggest that constraints in internal risk information can allow managers to use aggressive tax positions without fully considering interdependent non-tax risks. Results also help reconcile survey evidence of managers’ concern over non-tax risks with the limited archival evidence of managers’ acting on these concerns.