Tax Risk, Implied Cost of Capital, and Large Business Conglomerates

Guenther et al. (2017) find that firms with high tax risks have increased uncertainty in future cash flows. Therefore, as firm risk increases, the required return of shareholders increases. Tax risk is an important factor that indicates the sustainability of tax management. A sustainable tax strategy affects not only firm management but also investor decision-making. The Large Business Conglomerates refers to a firm that owns several affiliates and has huge financial power and huge capital. Large Business Conglomerates firms are required to disclose various information such as corporate finances and taxation according to the large-scale corporate group disclosure system. Therefore, investors demand accurate information about Large Business Conglomerates firms. This study is conducted from two perspectives. First, we examine the effect of tax risk on the implied cost of capital. Second, we examine whether the relationship between implied cost of capital and tax risk differs depending on the Large Business Conglomerates. As the results, first, tax risk positively related to implied cost of capital. Investors perceive tax-related uncertainty as a risk, resulting in a high cost of capital. We find that tax risk increases the cost of financing. Second, the positive relationship between implied cost of capital and tax risk was weakened in the firms affiliated with Large Business Conglomerates. We find that Large Business Conglomerates firms have more resource and experience to reduce tax risk than firms unaffiliated with Large Business Conglomerates. Our findings that sustainable tax planning affects financing costs provide useful information for investors and managers. By empirically demonstrating that investors assess tax risk differently based on whether they are affiliates of Large Business Conglomerates or not, it offers vital evidence to corporate stakeholders.