The taxman cometh: Does tax uncertainty affect corporate cash holdings?
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We examine whether firms hold more cash in the face of tax uncertainty. Because of gray areas in the tax law and aggressive tax avoidance, the total amount of tax that a firm will pay is uncertain at the time it files its returns. The tax authorities can challenge and disallow the firm’s tax positions, demanding additional cash tax payments. We hypothesize that firms facing greater tax uncertainty hold cash to satisfy these potential future demands. We find that both domestic firms and multinational firms hold larger cash balances when subject to greater tax uncertainty. In terms of economic significance, we find that the effect of tax uncertainty on cash holdings is comparable to that of repatriation taxes. Our evidence adds to knowledge about the real effects of tax avoidance and provides a tax-based precautionary explanation for why there is such wide variation in cash holdings across firms.
KeywordsCash holdings Tax avoidance Tax uncertainty FIN 48 Disclosures Long-run repatriation tax costs
JEL classificationG30 G32 H25
We thank Efraim Benmelech, Nittai Bergman, Lisa De Simone, Amy Dittmar, Shane Heitzman, Anzhela Knyazeva, Lil Mills, Kathleen Powers, Eddie Riedl, John Robinson, David Scharfstein, Richard Sloan (editor), Erin Towery (discussant), and two anonymous reviewers for helpful comments. We also thank workshop participants at Boston University, Harvard finance doctoral seminar, London Business School, McGill University, Santa Clara University, University of Houston Bauer Conference, University of Illinois at Urbana-Champaign, University of Miami, University of Rochester, University of Texas at Austin, American Accounting Association 2013 Annual Meeting, European Accounting Association 2013 Annual Congress, Washington University – St. Louis, and doctoral seminar participants at the University of North Carolina.
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