Product Market Threats and Tax Avoidance

Abstract

In this paper, we investigate whether product market threats have a significant impact on firms’ tax avoidance. By adopting the market fluidity measure introduced in Hoberg, Phillips, and Prahbala (2014) as a proxy for product market threats, we find that product market threats increase the level of tax avoidance activities of the firms which are pursuing such activities more than their target tax avoidance level (actively tax-avoiding firms), whereas that impact is not significant for the firms which have not been involved in tax avoidance activities more than their target level. Accordingly, actively tax-avoiding firms delay their adjustment toward the optimal target tax avoidance level significantly when facing product market threats. In addition, among these firms with active tax avoidance practice, especially the firms with worse corporate governance structure, lower levels of monitoring, higher information asymmetry, and lower financial flexibility are more likely to experience the positive relationship between product market threats and their tax avoidance. Further evidence suggests that higher levels of tax avoidance driven by product market threats do not come with higher levels of tax uncertainty and positively affect firms' profitability.