Investment Opportunity Sets, Operating Uncertainty, and Capital Market Pressure: Determinants of Investments in Tax Shelter Activities?

Prior research documents substantial variation in firms' tax avoidance activities and questions why some firms choose not to take advantage of the apparent benefits of tax planning (i.e., the "undersheltering puzzle''). We provide additional insight into the undersheltering puzzle by investigating the decision to invest in a tax shelter from the perspective of a firm's overall investment strategy. We examine whether three factors associated with traditional investment behavior (firms' investment opportunity sets, operating uncertainty, and capital market pressure) are also associated with investments in tax shelter activities. Our results suggest that firms with large investment opportunity sets and higher operating uncertainty are less likely to invest in tax shelters. We also find that firms with greater capital market pressure are more likely to invest in tax sheltering activities. Overall, we find that factors that influence firms' investment behavior help to explain why more firms do not invest in tax shelters.