1. RELATIVE VALUATION OF ALTERNATIVE METHODS OF TAX AVOIDANCE February 2013 Journal of the American Taxation Association Conference Kerry Inger, Auburn University

2. I NTRODUCTION Research Question: Do investors distinguish among methods of tax reduction in the valuation of tax avoidance? Contribution: Provide evidence that specific methods of tax avoidance have differential valuation implications

3. M OTIVATION Prior studies provide evidence that tax avoidance is associated with firm value Characteristics of specific types of tax avoidance could result in differential valuation across methods Decompose cash effective tax rate into methods of tax avoidance

4. P RIOR R ESEARCH Prior literature investigates association between firm value and: total tax avoidance (Desai and Dharmapala 2009), subset of tax avoidance (Wilson 2009, Koester 2011) impact of firm characteristics (De Simone and Stomberg 2012, Wang 2011)

5. H YPOTHESES 1. Varying risk profiles across tax reduction strategies 2. Permanent verse temporary nature of tax savings 3. Differing tax planning costs 4. Implicit taxes 5. Contrasts in disclosures of tax avoidance activities  H1: Investors differentially value specific methods of tax avoidance.

6. S UMMARY OF M ETHODS Reasons for differential value across methods of tax avoidance Method/ Characteristic Stock Option Benefits Accelerated Depreciation Foreign Income Residual Tax Deferral RiskLow High PermanenceYesNoQuasi Planning CostsLow High Implicit TaxNoPossibleNo DisclosureHigh Varies

7. H YPOTHESES H2A: Firm value is positively associated with tax avoidance generated through stock option tax deductions. Mehran (1995), Hanlon et al. (2003), Kahle and Shastri (2005) H2B: Firm value is not associated with tax avoidance generated through accelerated tax depreciation deductions. Raedy et al (2012), Amir et al. (1997), Ayers et al. (2011)

8. H YPOTHESES H2C: Firm value is positively associated with tax avoidance generated through the deferral of the residual U.S. tax on foreign subsidiary income. Collins et al. (2000), Bauman and Shaw (2008) H2D: The association between firm value and tax avoidance generated by deferral of the residual U.S. tax on foreign income is lower in firms operating in a tax haven. Cloyd et al. (2003)

9. S UMMARY OF M ETHODS Reasons for differential value across methods of tax avoidance Method/ Characteristic Stock Option Benefits Accelerated Depreciation Foreign Income Residual Tax Deferral RiskLow High PermanenceYesNoQuasi Planning CostsLow High Implicit TaxNoPossibleNo DisclosureHigh Varies HypothesisH2AH2BH2C Prediction>0=0>0

10. R ESEARCH D ESIGN F IRM V ALUE M ODEL  H1: β 1 ≠ β 2 ≠ β 3 ≠ β 4  H2A: β 1 > 0  H2B: β 2 = 0  H2C: β 3 > 0 Firm Value = Tobin’s Q = Ratio of market value to book value of firm Firm Value it =β 0 + β 1 STOCK AVOID it + β 2 DEPR AVOID it + β 3 RESIDUAL AVOID it + β 4 OTHER AVOID it + ∑Control Variables it + ε it

11. T AX A VOIDANCE M EASURES Tax Avoidance Derived from: =÷Pre-tax Book Income - Special Items CETRCash Taxes Paid STOCK AVOIDCash tax benefit of stock options+ Stock Option Compensation Expense* DEPR AVOIDΔ DTL PPE RESIDUAL AVOIDΔ Residual Tax on permanently reinvested foreign earnings + Δ DTL Unremitted foreign earnings OTHER AVOIDCETR AVOID # – STOCK AVOID – DEPR AVOID – RESIDUAL AVOID *123R observations # CETR AVOID = 35% - CETR

12. S AMPLE Fortune 500, 1997-2010 Hand collected data: Statement of Cash Flows Statement of Equity Income Tax Footnote Share-based Compensation Footnote Exhibit 21 Subsidiaries of Registrant Text search program Compustat, CRSP, Execucomp, Audit Analytics

13. Primary Results Firm Value and Tax Avoidance Table 4: Firm Value and Alternative Methods of Tax Avoidance Model Variables of InterestPrediction3 year CETRHypotheses STOCK AVOID> 01.843** H2A Supported DEPR AVOID= 0.054 H2B Not rejected RESIDUAL AVOID> 0-1.37*** H2C Rejected OTHER AVOID.258* Options.79*** PPE.078 Foreign Income9.596*** Adj. R 2 48.07% Control variables omitted for brevity. H1 Supported Test of coefficient equality on all AVOID variables rejected (p-value range.0009-.0396). H1 Supported *,**,*** indicates significance at 1%, 5% and 10%.

14. F IRM V ALUE M ODEL – T AX H AVENS  H2D: β 4 < 0 Haven = 1 if presence in a tax haven following Dyreng and Lindsey (2009) Firm Value it =β 0 + β 1 STOCK AVOID it + β 2 DEPR AVOID it + β 4 RESIDUAL AVOID it *Haven it β 3 RESIDUAL AVOID it + β 4 RESIDUAL AVOID it *Haven it + β 5 OTHER AVOID it + ∑Control Variables it + ε it

15. Primary Results Table 5: Firm Value and Alternative Methods of Tax Avoidance Model Additional Analysis of RESIDUAL AVOID: Tax Haven Interaction Variables of InterestPrediction3 year CETRHypotheses STOCK AVOID1.853** DEPR AVOID.059 RESIDUAL AVOID-1.111 RESIDUAL AVOID*Haven< 0-1.499*** H2D Supported OTHER AVOID.263* Haven-.028 Adj. R 2 48.06% Control variables omitted for brevity. *,**,*** indicates significance at 1%, 5% and 10%.

16. F IRM V ALUE M ODEL – R ESIDUAL DEFERRAL Firm Value it =β 0 + β 1 STOCK AVOID it + β 2 DEPR AVOID it + β 3 PRETAX DISCLOSE AVOID it β 3 PRETAX DISCLOSE AVOID it + β 4 PRETAX ESTIMATE AVOID it β 5 PROVIDE AVOID it β 4 PRETAX ESTIMATE AVOID it + β 5 PROVIDE AVOID it + β 6 OTHER AVOID it + ∑Control Variables it + ε it Tax Avoidance Derived from:= ÷Pre-tax Book Income - Special Items RESIDUAL AVOID = PRETAX DISCLOSED AVOID + PRETAX ESTMATE AVOID + PROVIDE AVOID PRETAX DISCLOSED AVOIDΔ Residual Tax on permanently reinvested earnings (Disclosed) PRETAX ESTIMATE AVOIDΔ Residual Tax on permanently reinvested earnings (Estimated) PROVIDE AVOIDΔ DTL Unremitted foreign earnings

17. Primary Results Table 5: Firm Value and Alternative Methods of Tax Avoidance Model Additional Analysis of RESIDUAL AVOID: Expansion of RESIDUAL AVOID Variables of Interest3 year CETR STOCK AVOID1.881** DEPR AVOID.131 PRETAX DISCLOSE AVOID -1.712** PRETAX ESTIMATE AVOID -.339 PROVIDE AVOID -1.616* OTHER AVOID.346** Adj. R 2 48.7% Control variables omitted for brevity. *,**,*** indicates significance at 1%, 5% and 10%.

18. Results Summary Results support differential valuation of methods of tax avoidance Tax avoidance derived from: stock option tax benefits positively associated with firm value. accelerated tax depreciation not associated with firm value. deferral of residual U.S. tax on foreign earnings negatively associated with firm value. Discount limited to firms with operations in a tax haven. Negative association driven by disclosure of residual tax liability.

19. Contribution Use traditional measure of tax avoidance in a new way to study specific methods of tax avoidance Extend literature on association between tax avoidance and firm value Support value relevance of tax-related information disclosed in financial statements, footnotes and exhibits