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Keywords: We examine the association between local gambling preference culture and corporate tax
Financial constraints avoidance. Using a firm’s county-level Catholics-to-Protestants ratio as a proxy for local gambling
Local gambling preference preferences, we find a positive and significant association between local gambling preference and
Risk taking
corporate tax avoidance activities. Our main result is driven by a high risk-taking channel and is
Tax avoidance
most pronounced for firms experiencing financial constraints. Finally, we find that improved
owners-managers alignment strengthens the link between local gambling preference and tax
avoidance.
1. Introduction
The fact that the tax burden takes away a large slice of a company’s operating profit, has resulted in an influential strand of
literature on how a firm can avoid tax. Prior research demonstrates that corporate tax avoidance is systematically associated with firm-
specific properties (Frank, Lynch, & Rego, 2009; Graham & Tucker, 2006; Gupta & Newberry, 1997; Wilson, 2009), characteristics,
incentives, and abilities of the top executives (Dyreng, Hanlon, & Maydew, 2010; Koester, Shevlin, & Wangerin, 2017; Law & Mills,
2017; Rego & Wilson, 2012), and firms’ monitoring mechanisms (Desai & Dharmapala, 2006; Hanlon & Slemrod, 2009; Khan, Sri
nivasan, & Tan, 2017). Despite the growth of tax avoidance literature in recent decades, Shevlin (2007) argues that we still do not fully
understand why some firms are more tax aggressive than others. In line with this call for more studies, recent analyses are exploring the
role of local geography in corporate tax avoidance (Hasan, Hoi, Wu, & Zhang, 2017). We aim to contribute to the emerging field of tax
avoidance literature, by examining the link between locally held gambling attitudes and corporate tax practices.
The possible link between local gambling preference and corporate tax avoidance is built on several compelling economic ratio
nales. First, in a gambling-intense society, people may increasingly become careless about social good. For example, Gupta and
Derevensky (1998) demonstrate that a significant number of adolescent gamblers steal money from their parents. Yeoman and Griffiths
(1996) also provide evidence that younger adolescents who gamble excessively may engage in stealing and commit other criminal
offences to fund their habit. Ursua and Uribelarrea (1998) demonstrated that gambling makes individuals careless about the welfare
and priorities of the family and the wider community. Accordingly, firms located in higher gambling preferences are likely to
personalize the behavior of indifference toward society and engage in diverting funds from the federal government to benefit
* Corresponding author.
E-mail addresses: S.Alharbi@latrobe.edu.au (S. Alharbi), N.Atawnah@ecu.edu.au (N. Atawnah), M.AlMamun@latrobe.edu.au (M. Al Mamun),
M.Ali@latrobe.edu.au (M.J. Ali).
https://doi.org/10.1016/j.gfj.2020.100585
Received 17 August 2020; Received in revised form 12 November 2020; Accepted 13 November 2020
Available online 24 November 2020
1044-0283/© 2020 Elsevier Inc. All rights reserved.
S. Alharbi et al. Global Finance Journal 52 (2022) 100585
1
The sample stops at 2010 since this study obtains data regarding religious adherence from the Association of Religion Data Archives (ARDA).
This organization updates data on religious adherence based on census data. 2010 is the latest census year in the USA.
2
S. Alharbi et al. Global Finance Journal 52 (2022) 100585
2006; Hanlon & Slemrod, 2009; Wilson, 2009). A growing trend in the literature, however, focuses on the influence of external culture
on tax avoidance behavior. For example, Hasan et al. (2017) document the role of local social capital in curbing firms’ tax avoidance.
Similarly, Boone, Khurana, and Raman (2013) document the role of religious adherence in curbing individuals’ and firms’ tax
avoidance behavior. Literature also documents the role of faith and trust in tax morale (Torgler, 2006), the role of religiosity in tax
fraud and tax fraud acceptability (Stack & Kposowa, 2006). Extending this line of enquiry, we demonstrate that local gambling culture
promotes risky and selfish behavior such as tax aggressiveness among local firms.
Several papers examine the role of faith and religious adherence to tax behavior. For example, Torgler (2006) examines the role of
faith and trust in tax morale in cross-country settings. Stack and Kposowa (2006) discuss the role of religiosity in tax fraud and tax
fraud acceptability. Elsewhere, Boone et al. (2013) investigate the role of religious adherence in individual and corporate tax
avoidance behavior. While our paper extends these studies, we emphasize issues that are very different from these papers. Firstly, there
are clear differences in the literature when talking about tax morale, tax evasion and tax avoidance. Similarly, there are clear dif
ferences in the lexical meanings of faith, trust, religious adherence, and gambling preferences. For example, Dyreng, Mayew, and
Williams (2012) consider honesty to be a form of religious adherence. Hence, at a conceptual level, faith and religious adherence are
not entirely the same as gambling.
Secondly, while religious adherence is viewed as risk-aversion, there is lack of direct empirical testing to support such a notion.
Moreover, conceptually risk-aversion is the lack of preference for variance in returns. However, the Catholics-to-Protestants ratio
captures gambling preference, i.e. the preference for skewness in returns. Variance vs. skewness in returns are significantly different in
econometric terms, captures two different spectra of the return distribution, and represent two different behavioral traits.2
Thirdly, while religious adherence and local gambling preference measures originate from similar databases, there is a significant
economic difference between religious adherence and local gambling preference measures. For example, religious adherence is the
fraction of total population claiming to have an affiliation with churches (Boone et al., 2013). In contrast, local gambling preference is
the ratio of Catholic-to-Protestant adherents at the county level (Chen et al., 2014; Christensen et al., 2018; Kumar et al., 2011). A
closer look at Fig. 1 does suggest the distribution of religious adherents (panel A of Fig. 1) and the distribution of Catholic vs. Protestant
population (panel B of Fig. 1) is markedly different across the USA. Boone et al. (2013) capture the people from all sects of Christianity
as religious irrespective of their practising behavior and commitment to religious teachings. This crude measure does not capture the
critical differences that exist between these two major Christian sects – the Catholic and the Protestant. Relatedly, we argue that it is
important to recognize the difference between the Catholic and Protestant adherents given the history of theological differences
between them. Many Protestants perceive gambling as a sinful activity (Ellison & Nybroten, 1999). Hilary and Hui (2009) suggest that
studying Catholic and Protestant groups separately helps eliminate the possibility of correlated omitted variables since Catholic and
Protestant religious tenets differ. Accordingly, our measure captures the critical difference in the theological belief, tolerance and
consumption patterns of gambling and alcoholic products and services between Catholics and Protestants (Chen et al., 2014) at the
county level. It also captures the dominance or prevalence of certain views about gambling at the county level over others. Hence, it is
completely different from any crude measure of religious adherence. Finally, our paper proposes different economic reasons, different
sets of tests - exogenous change in local gambling preference, channels, conditioning environments - to document the relationship
between LNCPR and tax avoidance.
The rest of the paper is organized as follows. Section 2 presents the theory and hypothesis. Section 3 describes the research design.
Section 4 reports the univariate analysis. Section 5 explains the main empirical results and various robustness checks. Section 6
discusses the results for the risk-taking channel. Section 7 focuses on further analysis while Section 8 concludes the paper.
Motivated by agency theory, prior literature documents several firm-specific factors affecting the cross-sectional variation of tax
avoidance across firms. For example, Desai and Dharmapala (2006) demonstrate that increases in incentive compensation reduce tax
sheltering. Dyreng et al. (2010) document senior executives’ fixed effects on corporate tax avoidance. Chen, Chen, Cheng, and Shevlin
(2010) highlight the effect of family firms in low-level tax sheltering. McGuire, Omer, and Wang (2012) corroborate the theory that tax
experts and external audit firms can help a firm to engage in greater tax avoidance through their consulting services. Minnick and Noga
(2010) find that incentive contracts encourage management to engage in long-term tax avoidance activities. Rego and Wilson (2012)
demonstrate that executives’ equity risk incentives are positively associated with firm-level tax sheltering. Based on the theoretical
prediction of stakeholder theory, Lanis and Richardson (2012) report that corporate social responsibility (CSR) disclosure is negatively
associated with corporate tax avoidance activities. Similarly, Ortas and Gallego-Álvarez (2020) also document that CSR performance
reduces tax avoidance. Collectively, there is a rich body of literature examining the firm-level determinants of corporate tax
aggressiveness.
The ‘culture-free’ argument (Hickson, Hinings, McMillan, & Schwitter, 1974) suggests that size, technology, industry, or institu
tional factors play a more important role than culture in determining how organizations make decisions. Economics literature
traditionally viewed the ‘cultural explanation’ as the inability to describe economic phenomena based on sound and/or ‘rational’
economic principles (Zingales, 2015). However, in recent years the question has been more frequently asked about the relevance of the
‘culture-free’ argument in explaining firms’ behavior. More recently, culture has become more mainstream and, indeed, its
2
For example, the crash risk literature (Kim et al., 2011a; Al Mamun et al., 2020a; 2020b) is built on the skewness in return which is different
from the variance of return (Adams, Almeida, & Ferreira, 2005).
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S. Alharbi et al. Global Finance Journal 52 (2022) 100585
multifaceted nature presents a fertile ground for modern economics research. Local culture interacts with the firm through local
employees, local customers, and local suppliers’ channels (Chen et al., 2014). Hence, local culture can help shape what is important
and what is urgent for business and help in setting priorities for a corporation in attaining its value-maximizing goals. Overall, local
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3. Research design
Our sample includes all firms at the intersection of the Compustat database and Association of Religion Data Archives (ARDA). We
calculate tax avoidance measures using Compustat data, whereas the local gambling preference variable is calculated based on the
county level information concerning prevalent religious adherence from ARDA. All firm-level financial and accounting data are from
Compustat. Stock price data derived from the Centre for Research in Security Prices (CRSP). Institutional ownership data are from
quarterly common stock holdings of 13(f) institutions as compiled by Thomson Reuters. The data on analyst coverage comes from the
Institutional Brokers’ Estimate System (IBES) database. Our sample covers the years 1980–2010.4
Following prior studies, we remove firms from regulated utilities (SIC 4900–4999) and financial industries (SIC 6000–6999). We
3
Retrieved from https://www.irs.gov/statistics/collections-activities-penalties-and-appeals on 5th July 2020.
4
The Association of Religion Data Archives (ARDA) is available once every decade; the data is collected from surveys on religious affiliation in the
U.S. (1971, 1980, 1990, 2000, and 2010). We stopped at 2010 because that is when data availability ceases.
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also drop firm-year observation when sales and total assets and common shareholders’ equity, are less than 1 million USD, and when
the share price is less than $1. This generates a total of 19,393 firm-year observations without missing values for local gambling
preference, tax avoidance measures and firm-level control variables.5 The baseline regression is based on the dependent variable at
year t, and the main independent variable and all control variables are at year t-1. To control for potential outliers, all variables (except
dummy variables) were winsorized at the 1% and 99% levels. We provide a detailed description of the variables in the Appendix.
We use two measures of corporate tax avoidance. First, the cash effective tax rate (CETR) computed as the ratio of the cash tax paid
to pre-tax book income minus special items. This measure is widely used in the literature (Armstrong et al., 2012; Hasan et al., 2014;
Kubick, Lynch, Mayberry, & Omer, 2015). This measure captures the most efficient means of tax avoidance by firms since it directly
measures how much tax a corporation effectively pays. Dyreng et al. (2008) argue that a cash effective tax rate is more powerful as a
measure of tax avoidance since it considers the tax benefits of the employee stock option and is not affected by changes in accounting
estimates. Consistent with Hassan et al. (2014), we winsorize CETR such that it falls within the [0,1] interval to ensure a valid eco
nomic interpretation, where higher values represent lower levels of tax avoidance. A lower CETR represents a higher level of tax
avoidance.
Second, the GAAP effective book tax rate (GETR) computed as the ratio of total tax expense to pre-tax book income minus special
items. Book ETR captures the firm’s accrual-basis tax burden and reflects tax avoidance strategies that generate permanent differences
(Dyreng et al., 2010).
We collect the “Churches and Church Membership” of files from ARDA because these capture county-level geographical variation.
The data file contains county-level statistics including information about the number of Catholic and Protestant communities and their
respective church adherents in the county collected once in each decade ending in 2010 with the last census. Following previous
studies, we linearly interpolate the Catholic and Protestant population data in the intermediate years for each county in the USA and
use the natural logarithm of Catholic-Protestant ratios (LNCPR) as a measure of local gambling preferences at the county level (Alesina
& La Ferrara, 2002; Chen et al., 2014; Hilary & Hui, 2009; Kumar et al., 2011). This measure is built on prior evidence documenting
that Catholics, on average, gamble significantly more while Protestants are typically fervently opposed to all forms of gambling
(Kumar, 2009). Moreover, he finds that the LNCPR of a geographic region is significantly positively related to both participation in
state lotteries and the holding of stocks with lottery-type features.
Apart from the empirical literature, the main justification for using LNCPR as a measure of local gambling preference is that the
Protestant movement since its inception has shown strong moral opposition to gambling and lotteries. Protestant philosophy strongly
judges against gambling while Catholic philosophy is somewhat more accepting of the practices of gambling (Hoffmann, 2000). This
difference in the philosophy of faith between Catholics and Protestants is also reflected in their practices (Halek & Eisenhauer, 2001;
Kumar et al., 2011). The superiority of this measure over other measures of gambling preferences such as age, income, education, and
gender is that while the direction of the relationship between sociological factors and gambling is not as clearly established, the
empirical literature provides clear evidence of a link between diverse religious beliefs or views and gambling.6
Fig. 1 presents the distribution of Catholic and Protestant ratios across various counties in the USA. Fig. 1 shows that people of the
same theological belief, tolerance, faith, and tastes are likely to live in a cluster: a trend that is common to various sects. We also follow
previous research and define a firm’s location as the site of its headquarters from the Compustat Company Location Code to match the
county information with each firm (Coval & Moskowitz, 1999; Pirinsky & Wang, 2006).
To investigate the relationship between local gambling preference and tax avoidance, we regress corporate tax avoidance measures
on local gambling preference and the control variables, as follows:
Tax Avoidancei,t =αi + βi *LNCPRi,t− 1 + βj *Firm charateristicsi,t− 1 + βi *County charateristicsi,t− 1 + ∂i *Year effectsi,t−
(1)
1
Where Tax Avoidancei,t is measured by CETR and GETR for firm i in year t. Our key independent variable of interest is local gambling
preference, defined as the ratio of Catholics to Protestants in the county of the firm headquarters at year t-1 (LNCPRi,t-1). We include
several firm-specific control variables that account for heterogeneity in the level of tax avoidance between firms. Following prior
5
The number of observations for Cash effective tax rate (CETR) is 10,550 firm-year observations due to the data availability of the variables
needed to calculate the CETR from Compustat database.
6
Although another proxy for local gambling preferences could be the number of poker machines per county, per capita poker machines per
county, or per capita lottery sales in a county. Unfortunately, data for lottery sales over extended time periods is not readily available at the county
level.
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studies, we control for foreign income (FI), return on equity (ROE), multi-national operation (MNC), intangible assets (INTAN), firm
size (SIZE), leverage (LEV), market-to-book ratio (MTB), and analyst following (LNANAL) (Boone et al., 2013; Rego & Wilson, 2012;
Gallemore & Labro, 2015; Cheng, Huang, Li, & Stanfield, 2012; Chen et al., 2014).
To ensure that local gambling preference does not capture other local characteristics, we follow previous studies and control for
county characteristics including - religiosity (REL), marital status (MARSTA), male-to-female ratio (MTFR), and proportion of minority
population (MINOR). Year and industry fixed effects were included in all models to control for the effects of unobserved time-invariant
and industry-specific characteristics. All independent variables are lagged by one year to mitigate the issue of reverse causality.
Standard errors are clustered at the firm level. Detailed variable definitions are presented in the Appendix.
4. Univariate analysis
Panel A of Table 1 presents the descriptive statistics of the measures of corporate tax avoidance, measures of local gambling
preference, and for several control variables used in this study. The mean values of GETR and CETR are 0.283 and 0.206,
respectively. This is less than the U.S. statutory rate of 35% and consistent with previous studies (Cen et al., 2017; Dyreng et al.,
2010). The mean value of local gambling preference (LNCPRt-1) is 0.928, which is comparable to the mean value reported in Chen
et al. (2014).
Regarding the control variables, the mean firm size measured by the natural logarithm of total assets (SIZEt-1) is 4.504. The standard
deviation of SIZEt-1 is 2.236, indicating that firms in the sample have significant size differences. The mean of leverage (LEVt-1) is 0.253
and the mean value of growth opportunities measured by the market-to-book value of equity (MTBt-1) is 3.042. The summary statistics
of the remaining control variables are consistent with previous studies (Boone et al., 2012; Hoi, Wu, & Zhang, 2013; Kim et al., 2011).
Similarly, the summary statistics of other control variables related to local gambling preference such as religiosity (RELt-1), male-to-
female ratio (MTFRt-1), marriage ratio (MARSTAt-1), and minority population (MINORt-1) are consistent with the findings of Chen et al.
(2014) and Kumar et al. (2011).
In panel B of Table 1, we present the descriptive statistics for the variables used in this study in a way that shows their differences
based on the largest Protestant and largest Catholic populations state-wide. We subgroup the entire sample into two groups. First, the
most populous Protestant states where the size of the Protestant population is in the top 25% of the entire sample. Second, the most
populous Catholic states where the size of the Catholic population is in the top 25% of the entire sample.
Panel B of Table 1 shows that the average effective tax rate in most Catholic states is significantly lower than the average effective
tax rate in most Protestant states, suggesting that they are avoiding more taxes. For example, the mean of cash effective tax rate (CETR)
and book effective tax rate (GETR) is 0.204 and 0.284, respectively, for the sample representing the most Catholic states. Meanwhile,
the mean of cash effective tax rate (CETR) and book effective tax rate (GETR) is 0.221 and 0.295, respectively, for the sample rep
resenting the most Protestant states. The mean-test reveals that these differences in tax avoidance are statistically significant. In panel
C of Table 1 we present the results using the county instead of the state. The result also indicates that the average effective tax rate in
most Catholic states is significantly lower than the average effective tax rate in most Protestant states. This finding is consistent with
our ex-ante expectation and suggests that firms located in more gambling-prone areas engage in more aggressive tax avoidance
activities.
Table 2 presents the Pearson correlation matrix for LNCPR, CETR and GETR, and other firms- and county-level control variables for
the sample of this study. This table shows that the correlation between LNCPR and cash effective tax rate (CETR) is − 0.0500. Similarly,
the correlation between LNCPR and book effective tax rate (GETR) is − 0.0624. The correlation matrix, therefore, provides an initial
indication that local gambling preference increases firm-level tax avoidance activities. The LNCPRt-1 is negatively associated to firm
size (SIZEt-1), leverage (LEVt-1), and analyst following (LNANALt-1), while the LNCPRt-1 is positively associated with religiosity (RELt-1),
multinational operation (MNCt-1), foreign income (FIt-1), and minority population (MINORt-1).
5. Main results
In this sub-section, we conduct an OLS regression analysis to test the association between local gambling preference and corporate
tax avoidance. We present our results in panel A of Table 3. The dependent variable in columns (1), (2), and (3) is CETR, while the
dependent variable in columns (4), (5), and (6) is GETR. We run three separate specifications for each dependent variable. In Model 1
we include industry and year fixed effects but without any control variables. In Model 2 we introduce standard firm-specific controls.
In Model 3 we run the most robust model specification in which we include all the firm-level control variables, together with industry
and year fixed effects, as well as local demographic characteristics, as suggested by Chen et al. (2014).
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Table 1
Summary statistics.
Panel A: Descriptive statistics for the full sample.
Most Protestant Population by State VS Most Catholic Population by State Mean Diff.
Most Protestant Population by County Most Catholic Population by County Mean Diff.
Table 1 presents the summary statistics of the main variables used in this study. The sample period spans the period 1980 to 2010. Panel A presents the
summary statistics of the full sample. Panel B presents the most Protestant and most Catholic populations by state and Panel C presents the most
Protestant and most Catholic populations by county. Variable definitions are in the Appendix. All variables except dummies are winsorized at the 1%
level.
The results in panel A of Table 3 demonstrate that local gambling preference is significantly and positively related to corporate
tax avoidance aggressiveness. Specifically, we find that across all model specifications, the coefficient estimate on LNCPR is
negative and statistically significant at the 1% level in columns (1) to (6). The negative and statistically significant coefficient
implies two things: firstly, that local gambling culture of a firm’s headquarters significantly decreases the cash effective corporate
tax rate; and secondly, the GAAP effective tax rate, which means higher corporate tax avoidance. These findings do support our
main hypothesis.7
The results are not only statistically significant but also economically significant. For example, the coefficient estimates of local
gambling (LNCPR) reported in column (3), which is the most robust model specification using CETR as a proxy for tax avoidance, is
− 0.011. This coefficient estimate suggests that a one standard deviation increase in local gambling preference (LNCPR) is associated
with a decrease in CETR by 6.49% [(− 0.011*1.215)/0.206]. Similarly, for GETR specification in column (6), the coefficient estimate
suggests that a one standard deviation increase in local gambling preference (LNCPR) is associated with a decrease in GETR by 3.44%
[(− 0.008*1.215)/0.283].
To further highlight the economic significance of our results, we employ quartile regression techniques. The quartile regression
setting allows us to determine whether the relationship between local gambling preference and tax avoidance varies across the dis
tribution to provides a more complete view of the stochastic relationship among variables (Fitzenberger, Koenker, & Machado, 2013).
Consistent with our OLS results, the results in panel B show that the effect of local gambling preference (LNCPR) on both measures of
tax avoidance is negative and significant in each quartile. Moreover, as we move from the first quartile to the fourth quartile, the
coefficient of local gambling preference (LNCPR) on tax avoidance measures increases markedly, suggesting that the magnitude of tax
avoidance increases significantly at higher distribution of local gambling preference (LNCPR).8 Overall, the results in Table 3 suggest
that higher local gambling preference increases a firm’s propensity to avoid tax.
7
Untabulated results from variance inflation factors (VIF) suggest that our results do not suffer from a multicollinearity issue.
8
We thank the anonymous reviewer for the suggestion to use quartile regression to highlight the economic significance of our results.
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Table 2
Correlation matrix.
Variables 1 2 3 4 5 6 7 8
LNCPR 1 1
CETR 2 ¡0.0500* 1
GETR 3 ¡0.0624* 0.3858* 1
FI 5 0.0776* 0.1200* 0.1002* 0.1560* 1
ROE 6 − 0.0114 0.0617* 0.1075* 0.1178* 0.0487* 1
MNC 7 0.1205* 0.1442* 0.1605* 0.1926* 0.3645* 0.0426* 1
INTAN 8 − 0.2039* − 0.0056 − 0.0027 − 0.0938* − 0.0328* 0.0033 − 0.0762* 1
SIZE 9 − 0.0105 0.2772* 0.2781* 0.2741* 0.3916* 0.0777* 0.4799* 0.1030*
LEV 10 − 0.0190* − 0.1332* − 0.1381* − 0.1728* − 0.0603* 0.0246* − 0.0594* 0.0963*
MTB 11 0.0089 − 0.0135 − 0.0231* − 0.0127 0.0157* − 0.0038 − 0.0342* − 0.0261*
LNANAL 12 − 0.0108 0.0753* 0.0676* 0.0670* 0.2181* 0.0214* 0.1820* 0.2425*
REL 13 0.1974* 0.0169 0.004 0.0180* 0.0165* 0.0059 0.0428* − 0.0152*
MARSTA 14 − 0.0766* − 0.0068 0.0336* 0.0234* − 0.1009* − 0.0054 − 0.0883* − 0.0146*
MTFR 15 − 0.0388* − 0.0562* − 0.0795* − 0.0760* 0.0234* − 0.0062 − 0.0023 − 0.0061
MINOR 16 0.0493* − 0.0012 − 0.0256* − 0.0218* 0.1242* 0.0079 0.0714* 0.003
Variables 9 10 11 12 13 14 15 16
SIZE 9 1
LEV 10 − 0.0729* 1
MTB 11 − 0.0463* − 0.0717* 1
LNANAL 12 0.4255* − 0.0234* − 0.0065 1
REL 13 0.0403* 0.0201* − 0.0313* 0.0170* 1
MARSTA 14 − 0.1824* 0.0187* 0.0174* − 0.1046* − 0.0132 1
MTFR 15 − 0.0596* − 0.0312* 0.0223* 0.0323* − 0.4650* 0.3375* 1
MINOR 16 0.1816* − 0.0162* − 0.0109 0.1071* − 0.0597* − 0.6847* − 0.0728* 1
This table presents the correlation matrix for the variable under study over the period 1980–2010. This table only reports correlation significance at
the 5% level. All variables, except the dummy variables, are winsorized at 1%. The Appendix provides definitions of the variables.
Following Hasan et al. (2017), this section attempts to establish causality by utilizing firm relocation as a plausibly exogenous
shock to local gambling preference. It does not seem plausible that corporate tax avoidance strategies determine the level of local
gambling preference, suggesting that reverse causality is not a major issue plaguing the reliability of our results. However, it is
plausible that unobserved variables are jointly correlated with local gambling preference and corporate tax avoidance.
In our relocation analysis, we identify firms that have undertaken relocation decisions to compare how tax avoidance level changes
after changes in location. If this relationship is not purely coincidental, then one would expect that a company’s tax avoidance would
decrease (increase) if it relocates its headquarters to a county with a lower (higher) local gambling preference. We use corporate
headquarters addresses reported in 10-K filings to identify any relocation decisions. The relocation decision is identified if a firm
reports headquarters addresses in two different counties in its 10-K filings in two consecutive years. We identify 75 firms with a single
headquarters relocation during the sample period, of which 41 firms had a gambling preference-increasing relocation, and 34 firms
had a gambling preference-decreasing relocation. Furthermore, the sample consists of 92 firms with multiple headquarters’ relocation.
Of these, 48 firms have a gambling preference-increasing relocation, while 44 have a gambling preference for decreasing relocation.
Using this qualified sample, we estimate the following regression model:
where AFTERt-1 is a dummy variable for firms that have a relocation that equals one if the observation is from the period after the
relocation; otherwise it is zero. INCREASEt-1 is a dummy variable that equals one if a firm relocated its headquarters to a county with a
higher level of gambling preference, and zero for relocation with a lower level of gambling preference. All models include firm-level
characteristics, county-level characteristics, and industry and year dummies. We present our results in Table 4.
Given the empirical settings, the main variable of interest is the interactive term (AFTERt-1*INCREASEt-1) as it provides an estimate
of the difference in the change over time in corporate tax avoidance. Our results show that across both models and all measures of tax
avoidance, the coefficients for the interactive variable are all negative and statistically significant at the 10% level for multiple moves,
and at the 5% level for a single move. These results confirm that headquarters relocation to a higher gambling preference area exerts a
positive effect on a firm’s inclination to tax avoidance and vice-versa.
This section presents several robustness checks to validate the main results. Specifically, we show that our results are consistent
when: (i) using alternative measures of tax avoidance; (ii) employing alternative measures of local gambling; and (iii) using different
model specifications and estimation techniques. We report the robustness results in Table 5. The robustness tests are based on the most
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Table 3
Presents the effect of a firm’s local gambling preference on tax avoidance. In Panel A we present the OLS results. In Panel B we present the quartile
regression results. We use the cash effective tax rate (CETR) and GAAP effective tax rate (GETR) as a tax avoidance measure. The independent
variable and the other control variables are at year t-1. The t-values reported in parentheses are clustered by firm. All regressions include both
industry and year fixed effects. The 1%, 5% and 10% significance levels of the coefficients are denoted by ***, ** and *, respectively. All variables,
except the dummy variables, are winsorized at 1%. The Appendix provides definitions of the variables.
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Table 4
Local gambling preference and tax avoidance: relocation regression.
CETR GETR
This table presents the effect of headquarters relocation to examine the relationship between gambling preference and tax avoidance. The sample
consists of 75 firms with a single headquarters relocation. Of these, 41 firms have a gambling preference-increasing relocation and 34 firms have
gambling preference decreasing relocation. The sample also consists of 92 firms with a multiple headquarters’ relocation. Of these, 48 firms have a
gambling preference-increasing relocation and 44 firms have gambling preference decreasing relocation. We use tax avoidance measurement
measures based on cash effective tax rate (CETR); and GAAP Effective tax rate (GETR) as a dependent variable at year t. All empirical models control
for firm-level characteristics, county-level characteristics, and industry and year dummies. The t-values are reported in parentheses and clustered by
firm. Both industry and year fixed effects are included in all the regressions. The 1%, 5% and 10% significance levels of the coefficients are denoted by
***, ** and *, respectively. All variables, except the dummy variables, are winsorized at 1%. The Appendix provides definitions of the variables.
robust model specification, in which we include all firm-level control variables, together with local demographic characteristics, as
well as industry and year fixed effects. Standard errors are corrected for clustering at the firm level. For brevity we only report the
coefficients on the variables of interest.
In panel A of Table 5, we repeat the analysis from Table 3 except that we employ alternative measures of corporate tax avoidance to
ensure our baseline results are not sensitive to the specific measure of tax avoidance employed. Specifically, we utilize four additional
measures of tax avoidance: the long run cash effective tax rate over three years (CETR_3), the long-run book effective tax rate over three
years (GETR_3), discretionary tax (DTAX), and the probability of tax sheltering (SHELT). Details concerning the definitions of variables
can be found in the Appendix.
The results presented in panel A of Table 5 are consistent with those reported in Table 3. Specifically, the coefficient estimates on
LNCPR are negative and statistically significant across specifications (1) to (2), where the dependent variables are CETR_3 and GETR_3.
The coefficient estimates on LNCPR are positive and statistically significant for columns (3) and (4), where the dependent variable is
DTAX, and SHELT, respectively. Overall, the results presented in panel A of Table 5 are consistent with the notion that local gambling
culture of a firm’s headquarters increases the degree to which it engages in tax avoidance activities.
In panel B of Table 5, we utilize two additional measures of local gambling. The first comprises the ratios of Catholics to Protestants
in the county of the firm headquarters (CPR) without taking the natural log. For the second, we use lottery per capita (LPC), which is a
continuous measure calculated as total lottery spending in the state scaled by the population in at state-level where the firm is
headquartered (Christensen et al., 2018). This measure captures the actual spending on gambling activities, which is correlated with
other gambling activities and attitudes that are unobservable (Christensen et al., 2018). Results in the rows labelled (1) and (2) in panel
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Table 5
Robustness tests.
Panel A: Alternative proxies of tax avoidance.
This table reports the results of several robustness tests performed on the regressions of our main result. Panel A present the results using long-term
cash effective tax rate (CETR_3), long-term GAAP effective tax rate (GETR_3), discretionary tax (DTAX), and the probability of tax sheltering (SHELT)
as dependent variable at year t. The independent variable LNCPRt-1 is a firm’s local gambling preference and the other control variable is year t-1.
Panel B presents the use of alternative proxies of local gambling preference using cash effective tax rate (CETR); and GAAP effective tax rate (GETR) as
dependent variable at year t. Panel C presents the results using several econometric choices. The main specification shows the estimate from the
regression on the full sample as reported in columns (3) and (6) in Table 3. For brevity, the table only reports the year and industry fixed effects
defined based on 2-digit SIC codes, and standard errors are corrected for clustering of observations at the firm level. The industry, county and year
fixed effects are included in all the regressions. The 1%, 5% and 10% significance levels of the coefficients are denoted by ***, ** and *, respectively.
All variables, except the dummy variables, are winsorized at 1%. The Appendix provides definitions of the variables.
B of Table 5 indicate that local gambling preference is associated with higher corporate tax avoidance. Overall, the results demonstrate
that ours documented in Table 3 are not sensitive to the specific measure of local gambling.
Panel C of Table 5 presents the results using different model specifications and estimation techniques. In the row labelled (3), we
use the survey year sample that captures only the actual data, rather than projected data, thus overcoming the look-ahead bias that is
associated with linear interpolation (Chen et al., 2014). Since the local gambling preference is a county-level measure, in the row
labelled (4) we correct the standard errors for clustering at county-level rather than at the firm-level that is used for the baseline results.
In the row labelled (5), we use generalized least squares regression to minimize the effect of within-firm variation. The results in rows
(3), (4) and (5) show that local gambling preference is positively related to corporate tax avoidance and statistically significant.
Previous studies document that gambling activities increase among youth (Derevensky & Gupta, 2004), and especially in poor
counties (e.g. Pryor, 2008). In rows labelled (6) and (7) of panel C, we repeat the analysis from Table 3 except that we include both
poor county and the young as control variables. Poor counties constitute a dummy variable taking the value of one if the median
income of a county is less than the median income of the entire sample counties. Similarly, the young county is a dummy variable that
takes the value of one if the median age of a county population is higher than the median age of the entire sample county population.
The results in rows (6) and (7) show that the baseline results hold even after controlling for demographic characteristics such as poor
county and young county.
In this section, we further explore the underlying channel through which local gambling preference affects corporate tax avoidance.
The results presented up to this point suggest that local gambling preference increases the likelihood of engaging in tax avoidance
activities. One of the main premises behind this outcome is that the gambling preference encourages risk-taking behavior and captures
the risk-taking nature of a firm (Chen et al., 2014; Kumar, 2009; Meyer & Stadler, 1999; Williams et al., 2011). As such, providing
evidence that local gambling is related to tax avoidance through higher firm risk-taking is essential to our story.
Following Coles et al. (2006), we consider volatility to be a summary measure of the outcome of firm risk choices, research and
development expenditures to be a major input to increased risk through investment risk, and the leverage to be a major input to
increased risk through capital structure risk. As such, we use four proxies to measure the firms’ risk-taking behavior. First, we use the
volatility of earnings. Specifically, for each business with available earnings and total assets for at least five years over the sample
period, the deviation of the firm’s EBITDA/Assets from the county average for the corresponding year is computed before the five-year
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rolling standard deviation of each firm is eventually estimated (John et al., 2008). Second, we use firm stock volatility measured as the
annualized standard deviation of returns, estimated from monthly stock returns over the five years. Third, we use R&D expenditure
measured as the ratio of R&D expenditure to total assets. Fourth and finally, we use book leverage measured as the book value of long-
term debt to the book value of assets (Coles et al., 2006).
We define firms with high risk-taking behavior as those where the level of earnings volatility, stock volatility, R&D expenditure,
and book leverage is above the 75th percentile of the distribution. Conversely, we define firms with low risk-taking behavior as those
where the level of earnings volatility, stock volatility, R&D expenditure, and book leverage is below the 25th percentile of the dis
tribution. We construct two binary variables equal to one when the firm has a high (low) level of risk-taking, and zero otherwise. We
then interact with gambling preferences with the two indicator variables that we are conditioning on. We present our regression results
in Table 6.
The results in Table 6 reveal that firm risk-taking behavior plays a major role in influencing the relationship between local gambling
and tax avoidance. Specifically, we find that the connection between local gambling and tax avoidance is only significant for the sub-
sample of firms with high earnings volatility, high stock volatility, high R&D expenditure, and high leverage. An F-test reveals that the
difference between the coefficients is statistically significant at the 1% level in all specifications. These findings support the assumption
that firm risk-taking behavior drives our results, where firms with a greater propensity for a local gambling preference are likely to
engage in more risky activities, including aggressive tax avoidance.
7. Further analysis
In this section, we further explore the underlying factors that influence the association between gambling preference and corporate
tax avoidance, namely: (a) high financially constrained firms; and (b) firms with high managerial-shareholder alignment.
Prior studies show that tax avoidance strategies offer firms a potentially substantial source of internally generated liquidity when
financial constraints arise (Edwards et al., 2016; Law & Mills, 2015). Moreover, firms faced with financial constraints have higher
external financing costs (Lamont, Polk, & Saaá-Requejo, 2001). Firms with a higher local gambling preference culture make more risky
investments (Chen et al., 2014) and are known to experience more financial misreporting incidents (Christensen et al., 2018), so they
are likely to face more severe external financing difficulties. Furthermore, local gambling preference culture promotes resource
diversion behavior among the communities to avoid financial hardships (Ursua & Uribelarrea, 1998). For this reason, we expect the
baseline results to be stronger for firms with high financial constraints than others.
We test our empirical prediction using the Kaplan and Zingales (2000) (KZ) index, and a novel proxy of financial constraints based
on the fraction of uncertainty words in the 10-K filings proposed by Law and Mills (2015). We define firms with high financial con
straints as those where the level of financial constraints is above the 75th percentile of the distribution. Conversely, we define firms
with minimal financial constraints as those where the level of financial constraints is below the 25th percentile of the distribution. We
construct two binary variables equal to one when the firm has a high (low) level financial constraints, and zero otherwise (High Fin.
Cons. and Low Fin. Cons). We then interact with gambling preferences with the two indicator variables that we are conditioning on. We
present our regression results in Table 7.
The results presented in Table 7 show that financially constrained firms pursue more aggressive tax avoidance to provide additional
Table 6
Local gambling preference and tax avoidance: firm risk-taking.
Earnings Volatility Stock Volatility R&D Expenditure Book Leverage
LNCPR* High Risk (1) − 0.030*** − 0.022*** − 0.019*** − 0.018*** − 0.033*** − 0.026*** − 0.019*** − 0.011***
(− 5.26) (− 4.22) (− 3.60) (− 4.09) (− 5.02) (− 5.24) (− 3.56) (− 3.01)
LNCPR* Low Risk (2) − 0.001 − 0.004 − 0.003 − 0.006* − 0.007 − 0.003 − 0.009 − 0.005
(− 0.07) (− 1.29) (− 0.67) (− 1.81) (− 0.87) (− 0.97) (− 0.70) (− 0.31)
Difference in Coefficients 1–2 − 0.029*** − 0.018*** − 0.016*** − 0.012*** − 0.026*** − 0.023*** − 0.010*** − 0.006***
F-statistics (13.81) (9.49) (6.53) (9.29) (12.88) (15.75) (12.88) (15.75)
All baseline controls YES YES YES YES YES YES YES YES
Year FE YES YES YES YES YES YES YES YES
Industry FE YES YES YES YES YES YES YES YES
Observations 10,550 19,381 8902 15,305 10,550 19,381 10,550 19,381
Adj. R-square 0.13 0.18 0.11 0.15 0.13 0.19 0.12 0.17
This table presents the OLS regression results of measuring whether the effect of the gambling preference area on tax avoidance is affected by the
degree of a firm risk-taking. We interact with gambling preferences variable with the high (low) firm risk-taking and run the same regression as
Table 3. The dependent variables are tax avoidance measures. Detailed variable descriptions can be found in the Appendix. All regressions control for
industry and year fixed effects. Standard errors are corrected for clustering at the firm level and t-statistics are reported in parentheses. ***, **, and *
denote significance at the 1%, 5%, and 10% levels, respectively.
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Table 7
Conditioning on financial constraints.
KZ Use of Uncertainty Words
This table presents the OLS regression results of measuring whether the effect of gambling preference area on tax avoidance is affected by the degree
of a company’s financial constraints. We interact the gambling preferences variable with the high (low) financial constraints and run the same
regression as Table 3. The dependent variables are tax avoidance measures. Detailed descriptions of the variables can be found in the Appendix. All
regressions control for industry and year fixed effects. Standard errors are corrected for clustering at the firm level and t-statistics are reported in
parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.
internal funds, compared to less financially constrained firms. Across all columns (1) to (4), we discover that the association between
local gambling and tax avoidance is stronger for the sub-sample of firms with high financial constraints compared with the sub-sample
of firms with low financial constraints. An F-test reveals that the difference is statistically significant at the 5% level. These results
implied that financial constraints is an important factor influencing the positive association between gambling preference and tax
avoidance strategies.
We examine the effect that managerial-shareholder alignment has on firms’ tax avoidance strategies. Since tax avoidance activities
have been shown to enhance shareholder wealth (Khan et al., 2017), we anticipate that firms subject to greater oversight will pursue
more aggressive tax management strategies. We employ institutional ownership (IO) measure which is defined as the number of shares
held by institutions divided by the total shares outstanding. We also use analyst coverage as another measure of governance. We define
analyst following as the number of analysts covering the company during the year.
We define firms with high levels of institutional ownership (Analyst) as those where the level of “monitoring” institutions (Analyst
following) is above the 75th percentile of the distribution. Conversely, we define firms with low levels of institutional monitoring
(Analyst) as those where the level of “monitoring” institutions (Analyst following) is below the 25th percentile of the distribution. We
construct two binary variables equal to one when the firm has a high (low) level of institutional monitoring (Analyst), and zero
otherwise (High Governance and Low Governance). We present our regression results in Table 8.
Table 8
Role of governance.
Institutional Ownership Analysts Following
This table presents the OLS regression results on the effect that external oversight mechanisms have on the baseline result. We interact gambling
preferences variable with the high (low) Institutional Ownership and Analysts Following and run the same regression as Table 3. The dependent
variables are tax avoidance measures. Detailed descriptions of the variables can be found in the Appendix. All regressions control for industry and year
fixed effects. Standard errors are corrected for clustering at the firm level and t-statistics are reported in parentheses. ***, **, and * denote significance
at the 1%, 5%, and 10% levels, respectively.
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The results presented in Table 8 show that institutional ownership plays a significant role in affecting how firms in gambling
preference areas avoid tax. In both columns (1) and (2), we find that the association between gambling preference and tax avoidance is
stronger for the sub-sample of firms with high institutional ownership compared with the sub-sample of firms with low institutional
monitoring. An F-test reveals that the difference is statistically significant at the 5% level. This observation is important because it
suggests that institutional investors encourage companies to enhance their tax efficiencies as a way of maximizing shareholders’
wealth. These results are consistent with prior studies indicating a positive relationship between institutional ownership and tax
avoidance (Huseynov, Sardarli, & Zhang, 2017; Khan et al., 2017).
The results presented in columns (3) and (4) of Table 8 show that analyst following also plays a significant role in influencing how
firms in gambling preference areas adjust their tax management strategies. The coefficient on LNCPR* Governance is stronger among
the sample of firms that are followed by a large number of analysts. An F-test reveals that the difference in the magnitude of the
association is statistically significant at the 5% level. Overall, the results presented in Table 8 reveal that tax avoidance for firms in
gambling preference areas is more pronounced when managerial interests are aligned with shareholders’ interests.
Table 9
Gambling Preferences & Tax Avoidance: Interplay between firm risk-taking & financial constraints.
Earnings Volatility Stock Volatility R&D Expenditure Book Leverage
Panel A: High KZ
LNCPR* High Risk − 0.039*** − 0.036*** − 0.025*** − 0.029*** − 0.029*** − 0.027** − 0.010** − 0.017***
(− 3.45) (− 3.30) (− 2.69) (− 4.06) (− 2.60) (− 2.20) (− 2.22) (− 2.85)
LNCPR* Low Risk − 0.017 − 0.014 − 0.006 − 0.008 − 0.011 − 0.015** − 0.055 − 0.033*
(− 1.19) (− 1.61) (− 0.50) (− 0.87) (− 1.30) (− 1.79) (− 1.49) (− 1.76)
Baseline controls YES YES YES YES YES YES YES YES
Year FE YES YES YES YES YES YES YES YES
Industry FE YES YES YES YES YES YES YES YES
Observations 2034 2649 2034 2649 2034 2649 2034 2649
Adjusted R-squared 0.108 0.139 0.123 0.142 0.108 0.142 0.107 0.140
Panel B: Low KZ
LNCPR* High Risk − 0.037** − 0.031** − 0.024* − 0.021* − 0.027** − 0.023*** − 0.008 − 0.017
(− 2.58) (− 2.48) (− 1.74) (− 1.81) (− 2.56) (− 3.07) (− 0.40) (− 1.25)
LNCPR* Low Risk − 0.0024 0.0015 − 0.0002 − 0.0055 0.0058 0.0066 − 0.0107 − 0.0023
(− 0.31) (0.29) (− 0.02) (− 1.23) (0.59) (1.15) (− 1.41) (− 0.48)
Baseline controls YES YES YES YES YES YES YES YES
Year FE YES YES YES YES YES YES YES YES
Industry FE YES YES YES YES YES YES YES YES
Observations 2034 2649 2034 2649 2034 2649 2034 2649
Adjusted R-squared 0.1391 0.2093 0.1224 0.1986 0.1420 0.2126 0.1328 0.1976
This table presents the results on whether the effect of firm risk-taking on the relationship between gambling and tax avoidance depends on the level
of financial constraints. We first split our sample into high and low financial constraints sub-samples. We then interact gambling preferences variable
with the high (low) firm risk-taking and run the same regression as Table 3 for each sub-sample. The dependent variables are tax avoidance measures.
Detailed descriptions of the variables can be found in the Appendix. All regressions control for industry and year fixed effects. Standard errors are
corrected for clustering at the firm level and t-statistics are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels,
respectively.
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7.3. The interplay among firms’ risk-taking, financial constraints and governance
In this section, we employ additional sub-sampling analysis that highlights the interplay among firms’ risk-taking behavior,
financial constraints, and corporate governance to provide more informative result about our main analysis. First, we reproduce
Table 6 by separating the sample into high and low level of financial constraints (KZ index and Use of Uncertainty Words). Consistent
with our previous approach, we define firms with high financial constraints as those where the level of financial constraints is above
the 75th percentile of the distribution and vice-versa. We present the outcomes in Table 9.
We find that except for two models, the relationship between local gambling and tax avoidance is significant for the sub-sample of
firms with high earnings volatility, stock volatility, R&D expenditure, and leverage in both high and low level of financial constraints.
More importantly, we find that the coefficient of the LNCPR* High Risk is consistently more pronounced for firms having higher levels
of financial constraints than others, irrespective of how financial constraints are measured. Our results highlight the fact that faced
with higher risk-taking behavior, firms in local gambling preference areas engage in more tax avoidance activities when they
encounter higher levels of financial constraints.
Table 10
Gambling Preferences & Tax Avoidance: Interplay between firm risk-taking & governance.
Earnings Volatility Stock Volatility R&D Expenditure Book Leverage
This table presents the results on whether the effect of firm risk-taking on the relationship between gambling and tax avoidance depends on the level
of corporate governance. We first split our sample into high and low governance sub-samples. We then interact gambling preferences variable with
the high (low) firm risk-taking and run the same regression as Table 3 for each sub-sample. The dependent variables are tax avoidance measures.
Detailed descriptions of the variables can be found in the Appendix. All regressions control for industry and year fixed effects. Standard errors are
corrected for clustering at the firm level and t-statistics are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels,
respectively.
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Next, we examine the interplay among corporate governance, risk-taking behavior and tax avoidance. Table 6 separates the sample
into high and low levels of corporate governance (intuitional ownership and analyst coverage). Consistent with our previous approach,
we define firms with high levels of institutional ownership (Analyst following) as those where the level of ‘monitoring’ institutions
(Analyst following) is above the 75th percentile of the distribution and vice-versa. We present the results in Table 10.
We find that the impact of local gambling preference and tax avoidance is consistently significant for the sub-sample of firms with
high earnings volatility, stock volatility, R&D expenditure, and leverage in both high and low levels of corporate governance envi
ronment. More importantly, consistent with our corporate governance explanation in Table 8, we find that the coefficient of the
LNCPR* High Risk is more pronounced for firms with a better governance environment than others, irrespective of the measure of
corporate governance. Our results emphasize the fact that faced with higher risk-taking behavior, firms in local gambling preference
areas engage in higher levels of tax avoidance when they have higher owners-managers alignment.
8. Conclusion
We study how local gambling culture affects firms’ tax avoidance behavior. We find that firms in higher local gambling preference
areas engage in more tax avoidance activities. Our results are robust to a large set of controls and year industry fixed effects. We
document consistent evidence using firms’ relocation strategies as an exogenous change to their local gambling preference measures.
Furthermore, results show that the positive association between local gambling preference and tax avoidance is only pronounced when
firms display higher risk-taking behavior captured by higher earnings volatility, higher stock volatility, higher risky investment in
research and development, and higher financial leverage. Finally, we discover that the effect of local gambling preference on tax
avoidance is mainly pronounced when firms face significant financial constraints and experience more managerial-shareholder
alignment.
The findings of this study make important contributions to tax avoidance literature. Our findings corroborate previous research that
demonstrated the importance of local culture – social capital, religious adherence, local trust in tax behavior (Boone et al., 2012; Hasan
et al., 2017) of the firm. Our study is also relevant to the literature demonstrating that local gambling culture is a positive force in
encouraging risky and innovative investment (Chen et al., 2014). We show that such risky corporate action encompasses an aggressive
tax avoidance strategy. This study contributes to the literature by showing that while Protestant and Catholic beliefs share a quite
similar aversion to volatility (pure) risk (Hilary & Hui, 2009), they do reveal significantly different attitudes toward return skewness, i.
e. preference for risk (Kumar et al., 2011).
Dependent variables
CETR Cash effective tax rate, computed as cash taxes paid (Compustat TXPD) divided by pre-tax book income minus special items (Compustat PI - SPI).
GETR Book effective tax rate computed as a total tax expense (Compustat TXT) divided by pre-tax book income minus special items (Compustat PI - SPI).
Alternative measures
CETR_3 Long-run cash effective tax rate, computed as cash taxes paid (Compustat item TXPD) over the current year and previous two years divided by the
sum of pre-tax book income less special items (Compustat item PI_SPI) over the current year and the previous two years.
GETR_3 Long-run book effective tax rate computed as the total tax expense (Compustat TXT) over the current year and previous two years divided by the
sum of pre-tax book income minus special items (Compustat item PI_SPI) over the current year and the previous two years
DTAX DTAX is an estimate of discretionary permanent book tax differences computed following Frank et al. (2009). DTAX is computed as the residual
from the following equation estimated at the industry-year level with at least 20 observations:
PERMDIFF = β0 + β 1INTANGIBLES + β 2UNCON + β 3MI + β 4CSTE + β 5DNOL + β 6LAG PERMDIFF + ℇit
Where: PERMDIFF = {PI – [(TXFED + TXFO)/0.35]-[TXDI/0.35)]}/ATt-1; INTANGIBLES = INTAN/ ATt-1; UNCON = ESUB/ ATt-1; MI = MII/ATt-
1; CSTE = TXS ATt-1; DNOL = (TLCF – TLCFt-1)/ATt-1.
SHELT Tax Shelter, the predicted probability of engaging in tax shelters computed following Kim et al. (2011).
LNCPR The natural logarithm of the ratio of Catholic residents to Protestant residents in the county where the firm is headquartered.
Lottery Per Total lottery spending in the state scaled by the population in at state-level where the firm is headquartered following Christensen et al.
Capita (2018).
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(continued )
Firm independent variables
Earnings Volatility Earnings Volatility is measured as the standard deviation of the previous 5 years ROE.
Stock Volatility The annualized standard deviation of returns, estimated from monthly stock returns over the previous year.
R&D Expenditure R&D expenditure measured as the ratio of R&D expenditure to total assets. We set missing observations of XRD as being equal to 0.
Book Leverage The book value of long-term debt to the book value of assets.
KZ Index KZ = − 1.002 [(ib + dp)/lagged ppent] + 0.283 [(at + prcc fxcsho − ceq − txdb)/at] + 3.139 [(dltt + dlc)/(dltt + dlc + seq)] − 39.368
[(dvc + dvp)/lagged ppent] 1.315(che/lagged ppent).
Use of Uncertainty The number of uncertainty words divided by the total number of words. Examples are ‘approximate’, ‘contingency’, ‘depend’, ‘fluctuate’,
Words and ‘uncertain’. We followed Bodnaruk et al. (2015).
CETR GETR
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(continued )
Panel A: Baseline results - OLS regression
CETR GETR
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