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Industry Product Market Competition and Efficiency of Corporate Tax Management

Economic theory suggests that product market competition should enhance firm performance. However, relatively little empirical evidence supports this long-held belief. We use the U.S. corporate tax management setting to test the relationship between product market competition and firm performance. We find that firms in competitive industries manage their taxes more efficiently than their counterparts in non-competitive industries. Specifically, we document that firms in competitive industries exhibit lower effective tax rates than their noncompetitive counterparts. Furthermore, we find that the positive link between competition and tax management efficiency is much stronger for firms with lower cash flow volatility and for firms with fewer industry investment opportunities. Finally, we find that increased regulation and tax enforcement do not weaken the effect of competition on the efficiency of tax management. Further analysis reveals that firms in competitive industries resort mainly to tax planning strategies other than abusive tax sheltering to manage taxes.