This paper uses a pass-through setting to circumvent two concerns cited in previous literature when testing the relation between taxes and investment efficiency. These concerns are the confounding effects of tax regulations, and the endogeneity of managers’ tax decisions. Using the shares held by tax sensitive investors as a tax proxy, the results suggest that an increase in the percentage of shares held by tax sensitive is related to an increase in underinvestment. In an additional analysis, using the Tax Cuts and Jobs Act (TCJA) as an exogenous tax shock, the results show a positive relation between debt to EBITDA ratios for underinvested firms after the TCJA compared to before the TCJA.

Do Taxes Relate to Investment Efficiency?

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