Investors punish companies that dodge tax a new study finds

Companies that engage in aggressive tax avoidance may be saving money in the short term, but they are paying a hidden price in the eyes of investors.  According to a new study by the University of Portsmouth, tax transparency is rewarded in capital markets while secrecy raises the cost of finance. 

The research shows that multinational corporations (MNCs) that avoid tax and obscure their global activities face higher costs when raising funds from investors. By contrast, firms that are more transparent about where they operate and pay tax generally find it cheaper to attract investment, suggesting that markets are increasingly wary of opaque tax practices. 

The study was motivated by a series of high-profile tax avoidance scandals involving some of the world’s largest multinationals. Companies such as Amazon were criticised for paying virtually no corporation tax in the UK between 2011 and 2013 despite reporting a UK turnover of £7.6bn (The Guardian 2019), prompting widespread public outrage and political scrutiny. 

“Tax avoidance doesn’t happen in a vacuum,” said Professor Jia Liu, Professor of Finance, Director of the Centre for Innovative and Sustainable Finance, University of Portsmouth.  “It creates uncertainty for investors about regulatory risk, future cash flows and reputational damage. Our evidence shows that investors respond to that uncertainty by demanding a higher return.” 

Using data from the 500 largest non-financial multinational corporations operating in Europe between 2007 and 2018, the researchers examined the relationship between tax avoidance, voluntary country-by-country (CbC) reporting and the cost of equity capital. CbC reporting involves disclosing where profits are earned and taxes are paid across different jurisdictions, information that is usually submitted privately to tax authorities but rarely made public. 

The findings suggest that companies engaging in lower levels of tax avoidance are significantly more likely to disclose CbC information voluntarily in their annual reports. Those disclosures, are associated with a lower cost of equity capital, indicating that investors view transparency as a signal of lower risk and better corporate governance. 

“Voluntary disclosure sends a powerful message,” explained Professor Jia Liu. “When companies are open about their global tax position, investors interpret that as a sign that managers have less to hide and that the firm is less exposed to regulatory shocks or public backlash.” 

Firms that engage in tax avoidance tend to limit what they disclose, particularly when operating in countries with high levels of financial secrecy. The study finds that this lack of transparency comes at a cost. Investors appear to penalise companies that combine high levels of tax avoidance with low levels of disclosure by demanding higher expected returns on their investment. 

The research also shows that investors are not easily fooled by what the study describes as “hypocritical transparency”. Firms that publish extensive CbC information but continue to engage in high levels of tax avoidance do not enjoy the same reduction in capital costs as genuinely transparent firms. 

“Investors can distinguish between meaningful disclosure and box-ticking,” said Professor Jia Liu. “Transparency only pays when it is backed up by responsible tax behaviour.” 

The findings come at a time of growing international concern over corporate tax avoidance. According to the State of Tax Justice report, multinational corporations are estimated to be sheltering around £1tn in profits in tax havens each year, depriving governments of roughly £179bn in annual tax revenues.  

The study adds to the debate over whether country-by-country reporting should remain a private exercise between companies and tax authorities or be made public.  

“Our evidence suggests that transparency has real economic consequences,” explained Professor Jia Liu. “If policymakers want to curb tax avoidance, public country-by-country reporting would not only support tax authorities but also allow investors to price risk more accurately.” 

The study concludes that tax avoidance is no longer just a moral or political issue but a financial one. In a world of heightened scrutiny, companies that continue to shift profits into secrecy jurisdictions may find that the cost of capital, quietly but steadily, rises against them.