Taxes and Financial Constraints: Evidence from Linguistic Cues

Linguistic cues reveal tax avoidance beyond traditional accounting measures

Key Takeaways:

• Firms that use negative words in their annual reports (indicative of financial constraints) are more likely to engage in tax avoidance behaviors such as reporting higher unrecognized tax benefits and using tax havens.

• The study provides evidence of causality by showing that financial constraints resulting from the unexpected closure of local banks lead to increased tax avoidance.

• The use of negative words in annual reports is a powerful tool in identifying a company's aggressive tax planning activities, beyond traditional accounting measures.