Stock Price Reactions to News of Tax Aggressiveness in Korea

This study examines how stock prices react to news of tax avoidance in Korea by applying the view of Hanlon and Slemrod (2009) on how news of tax shelter involvement affects the stock prices. We extend Hanlon and Slemrod (2009) by examining the differences among market reactions to acts of corporate misconduct such as unfair trade practice and accounting fraud. We use an event-study research methodology to evaluate the market reaction to acts of corporate misconduct including tax avoidance, unfair trade practices, and accounting fraud. We test the following hypotheses through t-tests: (1) the market reacts negatively to news that a firm is involved in tax avoidance; (2) firms with a higher cash effective tax rate (ETR) experience a less negative (i.e. more positive) reaction to news of tax avoidance; (3) retail industry firms, which deal closely with customers, experience a more negative reaction than other firms; (4) poorly-governed firms experience a more negative market reaction than well-governed firms; and (5) firms alleged to tax avoidance experience a less negative reaction than firms alleged to unfair trade practices and accounting fraud. Cumulative average abnormal return is employed to investigate the relationship between market reaction and news of corporate misconduct such as tax avoidance, unfair trade practices, and accounting fraud. The cash effective tax rate(ETR), our measure of tax avoidance, is defined as cash taxes paid divided by pre-tax accounting income. The retail industry is used to reflect consumer reaction, and the ownership percentage of controlling shareholders, foreign shareholders, and institutional shareholders are employed as governance variables.