The Inevitable Disclosure Doctrine and Corporate Tax Avoidance

Abstract

In this study, we investigate the effect of the protection of trade secrets through the adoption of the inevitable disclosure doctrine (IDD) by US state courts on corporate tax avoidance. We suggest a positive impact of IDD adoption on tax avoidance because IDD adoption reduces information transparency by increasing the benefit of nondisclosure and, hence, creates greater opportunities for firms to engage in more aggressive tax avoidance activities. Based on a large sample of US firms between 1977 and 2011, we find a significant increase in tax avoidance for firms in states that have adopted the IDD, compared with firms in states that have not adopted it. We further show that the impact of the IDD on corporate tax avoidance is more salient in firms with lower internal information quality. Our findings have important implications for both investors and regulators.