Bridget Stomberg

Internal Control Quality: The Role of Auditor-Provided Tax Services

We propose that auditor-provided tax services (tax NAS) improve internal control quality by accelerating audit firm awareness of transactions material to the financial statements. Using data from 2004 to 2012, we find robust evidence that companies purchasing tax NAS are significantly less likely to disclose a material weakness and that this result is not due to auditor independence impairment. A onestandard-deviation increase in tax NAS is associated with approximately a 13 percent decrease in the rate of material weaknesses relative to the base rate. These results are robust to tests addressing endogeneity concerns. Additional cross-sectional analyses reveal expected increased effects of tax NAS on internal control quality (1) after significant operational changes that require changes to the internal control structure, and (2) earlier in the relationship with the financial statement audit firm, when there are fewer established lines of communication between the audit team and client. This paper contributes to the knowledge spillover literature by identifying a mechanism through which tax NAS improve overall financial reporting quality.

The Relevance of Tax Cash Flow and Tax Expense

Empirical evidence on the relevance of cash flows and accruals, and changes in relevance over time is mixed. We extend this literature by examining the relevance of tax cash flow and tax expense. Income taxes offer a strong setting to study relevance because firms report both an accrual-based and cash flow-based measure of tax. We find the incremental predictive power of current-period tax cash flow for future tax cash flow is greater than that of current-period tax expense for future tax cash flow. Tax cash flow also dominates tax expense in explaining returns. Together, these results suggest tax cash flow is more relevant than tax expense. Our study extends the value relevance literature by demonstrating that specific accruals behave differently than aggregate accruals. Our study also informs the FASB’s decision about whether to require increased tax cash flow disclosure.

Examining the Role of the Media in Influencing Corporate Tax Avoidance and Disclosure

Managers express growing concern over media coverage of corporate taxes, yet no large-sample empirical study examines this phenomenon. As a first step to fill this void, we identify factors associated with the likelihood and negative tone of media tax coverage and examine firms’ tax avoidance behavior following media tax coverage. We find the likelihood of media tax coverage is greater for firms with GAAP effective tax rates below the top U.S. statutory rate of 35 percent and for firms with greater visibility. The degree of negative tone is increasing in cash tax avoidance and firm size. We also find evidence of more frequent and more negative tax coverage during economic recessions. We find no evidence that firms reduce their tax avoidance following media coverage. Although our analyses are subject to limitations, our results suggest the media may not have the same influence over corporate tax policy as other external stakeholders.

Let's Talk About Tax: The Determinants and Consequences of Income Tax Mentions During Conference Calls

This study uses voluntary income tax disclosures to examine how managers trade off the relative costs and benefits of voluntary disclosure. We first provide evidence that income tax mentions in quarterly earnings announcements and during earnings conference calls are increasing in tax reporting complexity. These results are consistent with managers attempting to improve the quality of the information environment through enhanced voluntary disclosure. However, we also find that income tax mentions are decreasing in the likelihood of near-continuous IRS audit, suggesting that proprietary costs discourage managers from voluntarily disclosing tax information. When comparing the magnitude of each effect, reporting complexity is a relatively more significant consideration in managers’ voluntary tax disclosure decisions on average. Even for firms with the highest proprietary costs, tax reporting complexity still affects voluntary disclosure decisions. When we examine specific tax disclosure topics, the relative importance of complexity and proprietary costs varies in expected ways. This study furthers our understanding of the relative importance of various inputs to the voluntary disclosure decision and provides insight into the drivers of voluntary income tax disclosures – a previously underexplored yet important area as regulators and activists worldwide call for greater tax transparency.

Trade-Offs between Tax and Financial Reporting Benefits: Evidence from Purchase Price Allocations in Taxable Acquisitions

U.S. GAAP requires assets acquired in business combinations to be recognized at fair value. The tax basis of assets acquired in taxable asset acquisitions must also be adjusted to reflect fair values. Managers can increase the net present value of cash tax savings by allocating a greater portion of the purchase price to shorter-lived assets. However, this conforming tax planning strategy results in lower book income immediately following the acquisition. Taxable acquisitions are therefore a powerful setting to investigate tradeoffs between tax and financial reporting benefits. We predict and find that managers with stronger tax incentives relative to financial reporting incentives shift a greater amount of the purchase price from intangible to depreciable assets. We also find that managers facing both strong financial reporting and tax incentives allocate more to intangibles relative to managers with only strong tax incentives. These results suggest managers trade off cash savings to report higher net income.

Examining Which Tax Rates Investors use for Equity Valuation

We propose that investors rely on tax rate heuristics to reduce information processing costs associated with understanding complex income tax information and examine which rate investors use to impound income taxes into firm value. We find that the top U.S. statutory rate is more associated with firm value than the firm’s prior year effective tax rate (ETR), prior three-year average ETR or prior-year industry-average ETR. However, we find that investors rely less on the statutory tax rate when the benefits (costs) of doing so are higher (lower). Specifically, when firms have more opportunities for long-term tax savings or when information processing costs are lower investors rely less on the statutory tax rate. Our findings have implications for management in communicating tax information to investors and for standard setters in understanding which tax information investors use.

Equity Compensation and Tax Avoidance: Incentive Effect or Tax Benefits?

We examine two competing explanations for the negative relation between equity compensation and tax avoidance documented in prior research. The first explanation suggests that equity compensation aligns managerial interests and reduces managers’ incentives to invest in tax avoidance schemes that facilitate rent extraction. The second explanation predicts that tax benefits from equity compensation reduce firms’ demand for additional tax avoidance by lowering its marginal benefits. We find evidence that the tax benefits from equity compensation, and not incentive alignment, drive the observed negative relation. Our findings suggest that researchers should consider the tax benefits of equity compensation to be of primary importance and control for these benefits when studying tax avoidance. Further, our results challenge the theory that managers use tax avoidance to facilitate rent extraction. Studies that rely on nefarious managerial behavior to motivate tax avoidance in the context of agency problems should reconsider the validity of this theory.