Who Invests in Corporate Tax Avoiders?

Abstract

We use detailed data on individual investors’ stock holdings to investigate whether corporate tax avoidance affects the willingness of individual investors to own stock. Consistent with corporate tax avoidance increasing both the perceived risk of owning stock and the costs of processing financial information, we provide robust evidence that individual investors own less stock of firms with low effective tax rates, our proxy for corporate tax avoidance. We then examine whether investor sophistication and investment strategies impact individuals’ willingness to own stock in firms with low effective tax rates. Our results suggest that more sophisticated investors and investors with shorter investment horizons own more stock in high tax avoidance firms, while more conservative investors own less. We also demonstrate that individual investors that own more stock in firms with low effective tax rates earn significantly higher abnormal stock returns than individual investors that own less such stock. Our results are robust to numerous control variables (including financial statement disclosure quality, as investigated in Lawrence 2013) and to an alternative measure of corporate tax avoidance. Overall, our findings suggest that less sophisticated and more conservative investors are less willing to own stock in corporate tax avoiders and thus, are at a disadvantage relative to other individual investors.