How Does Stock Liquidity Affect Corporate Tax Avoidance? Evidence from China

54 Pages Posted: 27 Jun 2019 Last revised: 4 Aug 2020

See all articles by E. Han Kim

E. Han Kim

University of Michigan, Stephen M. Ross School of Business

Yao Lu

Tsinghua University - School of Economics & Management

Xinzheng Shi

Tsinghua University - School of Economics & Management

Dengjin Zheng

Central University of Finance and Economics

Date Written: August 4, 2020

Abstract

Prior studies show stock liquidity improves price informativeness and strengthens governance. Stock price informativeness offers an incentive for managers with equity-based compensation to avoid tax. Strengthening governance, by contrast, reduces tax avoidance if diverting corporate profits for private benefits complements tax avoidance. Using an exogenous shock that drastically increased the liquidity of stocks listed in China, we find robust evidence that higher liquidity significantly increases the overall level of tax avoidance. The increase is more substantial when controlling shareholders own more shares, and when diversion is less complementary to tax avoidance. Liquidity has no significant impact on tax evasion—the most aggressive and risky tax avoidance—and at the higher ends of the tax avoidance distribution. The positive and significant effects are observed only at lower levels of tax avoidance. We attribute the weaker impact of liquidity on aggressive tax avoidance to diversion being more complementary to higher-risk tax avoidance.

Suggested Citation

Kim, E. Han and Lu, Yao and Shi, Xinzheng and Zheng, Dengjin, How Does Stock Liquidity Affect Corporate Tax Avoidance? Evidence from China (August 4, 2020). Available at SSRN: https://ssrn.com/abstract=3409700 or http://dx.doi.org/10.2139/ssrn.3409700

E. Han Kim

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-764-2282 (Phone)
734-763-3117 (Fax)

Yao Lu

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Xinzheng Shi (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Dengjin Zheng

Central University of Finance and Economics ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

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