Cash liquidity, holdings, and performance as determinants of corporate tax avoidance

Prior literature examines the determinants and consequences of tax avoidance in relation to earnings. Extending this research to the role of cash in motivating corporate tax avoidance, I consider a firm's liquidity, as measured by the quick ratio and free cash flows, insufficient cash holdings, as estimated by a model developed by Opler et al. (1999) and expanded by Oler and Picconi (2010), and its performance, relative to the consensus analyst operating cash flow per share forecast, as potential determinants of tax avoidance. Dyreng et al.'s (2008) cash effective tax rate is chosen as the tax avoidance metric of interest since it captures only avoidance that impacts the actual cash taxes paid and ultimately a firm's cash balance. In initial tests, I find tax avoidance is decreasing in liquidity and increasing in insufficient cash, in addition to evidence of an increase in tax avoidance for firms which meet or just beat the consensus cash flow forecast. After controlling for real activities-based earnings management, as measured following Roychowdhury (2006), results for liquidity are not robust for all measures, and insufficient cash is no longer significantly associated with the cash effective tax rate. These results highlight such controls as important considerations in future tax avoidance research. Finally, I find a decrease in the likelihood of more liquid firms entering into tax shelters based on the Lisowsky (2010) model.