Product Market Threats and Tax Avoidance

Abstract

In this paper, we investigate whether product market threats significantly impact firms’ tax avoidance. By adopting the market fluidity measure introduced in Hoberg, Phillips, and Prahbala (2014) as a proxy for product market threats, we find that product market threats increase the level of tax avoidance activities for the firms which are pursuing such activities more than their target tax avoidance level (thus, actively tax-avoiding firms). However, that relationship is not existent in the firms which have not been engaged in tax avoidance more than their target level. In addition, among these firms with active tax avoidance practice, especially the firms with worse corporate governance structure, lower levels of monitoring, higher information asymmetry, and lower financial flexibility are more likely to experience the positive relationship between product market threats and their tax avoidance. Further evidence suggests that higher levels of tax avoidance driven by product market threats do not come with higher levels of tax uncertainty and positively affect firms' profitability. This result highlights the decoupling relationship between tax avoidance and tax uncertainty as suggested by previous literature.