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1 Introduction
Tax avoidance is an important corporate strategy ([5] Cai and Liu, 2009; [23] Hanlon and Heitzman, 2010). Traditionally, it is believed that corporate tax avoidance represents wealth transfer from government to corporations and should enhance firm value. Nevertheless, tax avoidance is not costless. Direct costs include implementation cost, reputation loss and potential punishment, etc. Agency theorists argue that tax avoidance activities are also intertwined with corporate governance issues. Opaque tax planning activities camouflage managerial rent diversion and reduce firm value ([14] Desai and Dharmapala, 2006; [13] Desai et al. , 2007). Thus, whether a firm engages in tax avoidance depends on whether benefits outweigh costs. This paper extends the tax avoidance literature by examining the effect of tax avoidance on firm value in Chinese unique institutional setting. We expect the relation of tax avoidance and firm value varies with different levels of corporate governance.
Whether tax avoidance creates firm value is an important but under studied research question. Current empirical evidence on investors' reactions to tax avoidance is mixed. The research on information content of tax avoidance suggests that income tax expense is an indicator of corporation profitability. Tax avoidance reduces the information content of income tax expense ([24] Hanlon et al. , 2005; [2] Ayers et al. , 2009). [15] Desai and Dharmapala (2009) find that the overall effect of corporate tax avoidance activities on firm value is not significantly different from zero. The effect is positive only for those firm-years with high levels of institutional ownership. They argue that corporate tax avoidance has two competing effects on firm value. While it constitutes a wealth transfer from government to shareholders, the agency conflicts between managers and outside shareholders increase the likelihood of managerial diversion which is a minus of firm value. [22] Hanlon and Slemrod (2009) examine the market reactions to news about tax shelter involvement. They find limited evidence on cross-sectional variations of market reaction. [39] Wang (2010) finds that investors place a value premium on tax avoidance, but the price premium decreases as corporate opacity increases. Presumably, the inconsistency of research findings may be partly due to different selection of factors of interest, which have varying effects on current and future cash flows and ultimate firm value, and partly...