Tax Avoidance and Firm Risk: New Insights from a Latent Class Mixture Model

Michelle Hutchens, Sonja O. Rego, Brian Williams

Research output: Contribution to journalArticlepeer-review

Abstract

We examine the relations between tax avoidance and two components of firm risk (priced risk and idiosyncratic risk) using latent class mixture models. OLS regressions suggest that tax avoidance is negatively related to both priced risk and idiosyncratic risk. However, results from latent class mixture models reveal that 35.6 (58) percent of the sample exhibits a significant positive association between tax avoidance and priced (idiosyncratic) risk and firm characteristics are strikingly different across the latent classes. We use these differences to develop parsimonious models to predict latent class assignments, which we then use to demonstrate that firms predicted to have a positive relation between tax avoidance and priced risk or idiosyncratic risk have more negative future tax outcomes, including higher relative cash tax rate volatility, larger additions to tax reserves, larger payouts to tax authorities, and more negative tax-related news coverage over the following three years.

Original languageEnglish (US)
Pages (from-to)285-313
Number of pages29
JournalAccounting Review
Volume99
Issue number1
DOIs
StatePublished - Jan 2024

Keywords

  • idiosyncratic risk
  • latent class mixture model
  • priced risk
  • tax avoidance
  • uncertainty

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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