The Effect of Tax Expense Management and CSR Ratings on Investor Perceptions of Firm Value

Abstract

Recent archival literature finds that investors positively value tax management activities that reduce taxes paid. Yet recent press suggests a negative backlash against companies that do not pay their “fair share” in taxes. Little empirical evidence exists regarding investor perceptions of tax management. We posit that corporate tax activities are related to corporate social responsibility (CSR) and may be a component of CSR. We predict the interaction of tax management and CSR performance influences investor pricing behavior. We examine the impact of effective tax rates (ETRs) and CSR ratings on participants’ choice of stock price and perceptions about CSR. We find, in the absence of any other CSR information or when a firm has poor CSR performance, investors perceive firms that pay more taxes as more socially responsible than firms that successfully manage taxes downward. However, when CSR performance is high, tax management does not influence perceptions about CSR. Also, investors do not always price according to their perceptions of CSR. Although investors may perceive firms that pay more taxes as more socially responsible, they do not differentially price firms for taxes paid (or tax management) when CSR performance is low. When CSR performance is high, investors reward the firms that most effectively manage taxes – not the firms that pay more. We only find a price premium for firms that have both good CSR ratings and effectively manage their taxes. Our results are consistent with an interactive effect of CSR performance and tax management on investor estimates of firm value.