The reputation costs of tax avoidance of financial institutions

Abstract

This paper investigates empirically if financial institutions have reutation cost by practicing tax avoidance. We found that the reputation costs restrain Banks from being more aggressive in practicing tax avoidance. Thus, in this paper we empirically examine whether there are reputation costs for financial institutions when engaging in tax avoidance, especially during the protest period. For this purpose, we use a sample of 20,129 firm-years of U.S. public financial firms from Compustat, Capital IQ, CRSP and I/B/E/S. We use two measures of tax avoidance: GAAP ETR and CASH ETR. As proxies for reputation costs we use cumulative abnormal stock return, analysts’ recommendations and credit rating. The results confirm both hypotheses stating that financial institutions have reputation costs when practicing tax avoidance and during the protest period these costs are higher. The results also show that financial institutions that practice tax avoidance have a negative impact of 11.18% in their cumulative abnormal stock return. We also find that tax avoidance negatively affects analysts’recommendations by in 2.5% and during the protest period this effect is 5.9%. Furthermore, the results of sensitivity testing with quantile regression indicate that a higher level of tax avoidance is associated with higher reputation costs. This paper of the study contributes both to the financial and tax avoidance literature, especially with respect to the reputation costs of tax avoidance for financial institutions. This is one of the first studies to empirically investigate the reputation costs of financial institutions when practicing tax avoidance.