2015 Conference

Stock Liquidity and Tax Avoidance

This study establishes a causal link between stock liquidity and tax avoidance. High liquidity facilitates large trades and short selling, enhancing information dissemination regarding a firm’s performance and managers’ behavior. We argue that such improvements in a firm’s external information environment make tax avoidance more likely to be detected by external monitors, which reduces managers’ ex-ante incentive for tax avoidance. Consistent with our hypothesis, we find that high liquidity reduces firms’ tax-avoiding activities. To address endogeneity challenges, we exploit the variation in stock liquidity introduced by two exogenous shocks (tick size changes and stock splits).