Conforming Tax Avoidance and Capital Market Pressure

In this study, the authors develop a measure of corporate tax avoidance that reduces both financial and taxable income, which they refer to as “book-tax conforming” tax avoidance. The authors use simulation analyses, LIFO/FIFO inventory method conversions, and samples of private and public firms to validate their measure. They then investigate the prevalence of conforming tax avoidance within a sample of public firms. Results from the validation tests indicate that their measure of conforming tax avoidance successfully captures book-tax conforming transactions. Consistent with expectations, they also find that the extent to which public firms engage in conforming tax avoidance varies systematically with the capital market pressures. Their study develops a new measure of conforming tax avoidance that should be useful in future research and provides new insights on the extent to which public firms are willing to reduce income tax liabilities at the expense of reporting lower financial income