The effect of cost asymmetry on future tax avoidance

Abstract

This study explores the relationship between cost asymmetry and future tax avoidance. Cost stickiness is positively associated with adjustment costs, more optimistic managerial expectations of future performance, and intense managerial empire-building behavior. We expect that higher adjustment costs will increase future requirements for internal financing via tax avoidance. Additionally, self-interested managerial behavior and managerial expectations of improved performance and higher tax burden may enhance managers’ motives to engage in tax avoidance. We find a positive relationship between the prior period’s cost stickiness and the current period’s tax avoidance using a sample of 30,923 firm-year observations of US listed companies over the 2000–2019 period. Our results are more pronounced for firms with high adjustment costs and firms with high managerial expectations of future sales. The level of accrual earnings does not seem to affect our empirical results, which remain robust to alternative measures of tax avoidance, differences rather than levels in the variables, and macroeconomic event shocks. These findings remain consistent when the data are partitioned into samples and propensity scored for cost asymmetry.