The effect of stock market indexing on corporate tax avoidance

TL;DR

This study uses a regression discontinuity design based on index reconstitution to examine if stock market indexing influences corporate tax avoidance, finding no significant effect on effective tax rates.

Contribution

It introduces a novel application of index reconstitution as a regression discontinuity design to study the impact of stock market indexing on tax avoidance.

Findings

No significant difference in effective tax rates between firms just inside and outside the index.

The index reconstitution provides a credible identification strategy.

Stock market indexing does not appear to influence corporate tax behavior.

Abstract

Membership in the Russell 1000 and 2000 Indices is based on a ranking of market capitalization in May. Each index is separately value weighted such that firms just inside the Russell 2000 are comparable in size to firms just outside (i.e. at the bottom of the Russell 1000) but have much higher index weights. These features allow for the the annual reconstitution of these indices to be used as part of a regression discontinuity design to identify the effect of stock market indexing. Using this design, I investigate whether stock market indexing affects corporate tax avoidance. I find no evidence that firms just inside the Russell 2000 have significantly different effective tax rates than firms just outside.