Taxes and Financial Constraints: Evidence from Linguistic Cues

Cash-strapped companies talk negatively, plan taxes aggressively

Law, K. K. F., and Mills, L. F. (2015). Taxes and financial constraints: Evidence from linguistic cues. Journal of Accounting Research, 53(4), 777-819.

Key takeaways:

• When companies are strapped for cash, they tend to push the boundaries more in their tax strategies to free up additional internal funds, as evidenced by higher uncertain tax positions and lower tax rates.

• Analyzing the words companies use in their financial filings, especially the frequency of negative language, provides a window into which firms are likely to be the most aggressive tax planners.

• Even after accounting for many other factors, the linguistic clues companies leave in their disclosures contain valuable information for detecting tax avoidance that would otherwise be hard to identify from traditional financial metrics.

• The study demonstrates a novel application of natural language processing to gain insights into corporate tax behavior and financial constraints, contributing to the broader literature linking linguistic cues to real outcomes.