Tax Avoidance, Tax Risk, and the Volatility of Stock Returns

We explore the effects of tax avoidance and tax risk on stock return volatilities of U.S. firms. We find that firms with very low and very high levels of tax avoidance and firms with high levels of tax risk have more volatile stock returns. We observe that tax avoidance primarily affects stock return volatility through changes in investors’ cash flow expectations; in contrast, tax risk seems to affect stock returns through cash flow and discount rate channels. Furthermore, we find that changes in expected cash flows and discount rates are less offsetting for firms with extreme levels of tax avoidance and high levels of tax risk.