The interaction between incentive and opportunity in corporate tax planning: Evidence from financially constrained firms

Abstract

Prior studies document that incentive factors (i.e., equity compensation, shareholder activism, financial constraints, etc.) motivate managers to avoid more taxes, which suggests that managers overlook tax planning opportunities (TPOs) in the absence of incentives. In this study, I use a prediction model to capture TPOs and find that the positive association between financial constraints (my proxy for incentive) and tax avoidance is stronger for firms with higher levels of TPOs. My results are robust to a variety of identification strategies. To shed light on a possible source of tax uncertainty, I show moderate evidence that firms with lower levels of TPOs adopt risky tax planning strategies under financial constraints to increase tax avoidance. Overall, my study contributes to the literature by demonstrating corporate tax planning as an incentive-opportunity story and identifying an important cross-section in which the connection between incentive and tax avoidance is more prominent.