Who Gets to Play Dirty? Using Legitimacy Theory to Examine Investor Reactions to Differing Modes of Corporate Tax Minimization*

Abstract

This study examines how information about a corporation's tax minimization activities and primary operations jointly influence investor behavior. Prior research identifies fear of investor backlash as a primary curb on corporations' tax minimization. However, evidence for such reactions remains mixed. Drawing on the psychological framework of legitimacy theory, we predict and find that the interaction between operations-level validity and tax-level propriety influences investor behavior. For companies with lower perceived validity in their primary operations, perceived improper tax minimization elicits strong negative reactions from investors, while proper tax minimization partially compensates for a lack of validity. Conversely, companies with greater perceived operational validity are mostly insulated from negative reactions to tax strategies deemed improper. Thus, management concerns over the reputational risks of tax minimization may be misplaced in some contexts, as companies whose primary operations are more valued by society may be afforded more leeway in their tax strategies.