Does Greater Tax Risk Lead to Increased Firm Risk?

In this study we examine whether higher levels of tax risk are associated with increased firm risk, as perceived by capital market participants. Given the difficulties of measuring tax risk, we utilize four different proxies that prior research indicates capture greater tax-related uncertainty, including total unrecognized tax benefits (UTBs), current UTBs, discretionary permanent book-tax differences, and volatility in cash effective tax rates (ETRs). We provide robust evidence that discretionary book-tax differences and cash ETR volatility are positively associated with several measures of firm risk, while the UTB-based measures are either not associated with firm risk or negatively associated with firm risk. We also provide some evidence that low tax accrual quality drives the positive association between discretionary book-tax differences and firm risk. Our research increases our understanding of which tax metrics capture tax-related uncertainties that lead to assessments by investors and analysts of higher firm risk.