C. Bryan Cloyd

The use of financial accounting choice to support aggressive tax positions: Public and private firms

This paper describes one reason tax considerations might affect a firms financial accounting choices. If the appropriate financial accounting and tax treatments are ambiguous and the firm has chosen an aggressive tax treatment, we propose that management may choose a financial accounting method that conforms to the tax choice (i.e., conformity) in an effort to increase the probability that the Internal Revenue Service (IRS) will allow the tax treatment. In such cases management is using financial accounting methods to increase expected tax savings and cash flows. 1

Firm Valuation Effects of the Expatriation of U.S. Corporations to Tax Haven Countries

As a direct response to the recent trend in corporate expatriations, politicians have questioned the patriotism of firms that reorganize outside the U.S. and introduced numerous legislative proposals designed to prevent corporate expatriations. The implicit assumption made in proposing this legislation is that the expatriation trend is just beginning and that many more firms will follow suit to reduce their U.S. tax burdens. In this study, we investigate whether the share prices of expatriating firms react positively to initial announcements of intentions to expatriate to tax haven countries. Overall, we do not detect obvious shareholder benefits from expatriations. We analyze the statistical significance of each firms abnormal returns around the inversion announcement date using approximate randomization procedures. Specifically, we find that seven of the 19 single-company expatriations have significant negative announcement period returns and only two show significant positive returns. The remaining ten inversions show no statistically significant market reaction. The average return in the announcement period across all 19 firms is negative, but not significantly different than zero. Further, there is no consistent evidence of positive post-announcement returns. One policy implication of these results is that existing costs of expatriating might be sufficient to dissuade future expatriation without additional tax rule restrictions. At the very least, the track record of prior expatriations in failing to create substantial shareholder value might buy Congress some time to thoughtfully consider any legislative action that might be necessary. Because alternative avenues exist for firms to avoid, or at least substantially defer, U.S. tax on foreign income, a more comprehensive review of U.S. tax rules governing the taxation of foreign income may be needed.

Independent auditor litigation: Recent events and related research

Abstract The public accounting professions difficulties with litigation have been widely asserted (e.g., Hill and Metzger, 1992, pp. 263–265; Mednick and Peck, 1994. pp. 897–898; Miller and Young, 1997, pp. 1990–1991, 2027). Public accountants have recently won several major victories in their efforts to reduce litigation based on allegedly negligent auditing. We discuss three of the more important of these recent victories for public accountants and their implications for auditor litigation. We conclude that, despite recent events, the debate over independent auditor litigation is far from over and long-term trends are uncertain. We also briefly examine some of the recent research in response to the public accounting professions call in the early 1990s for academic research related to independent auditor litigation. In doing so, we briefly comment on some of the articles in this and the Winter 1997 issue of the Journal of Accounting and Public Policy which was dedicated to independent auditor litigation issues. We conclude that research to date in response to this call is providing useful evidence on litigation issues involving the profession, but that additional research is needed to shed light on unresolved issues. Suggestions are made for research that might address some of these questions.

Capitalization of Shareholder Taxes in Stock Prices: Evidence from the Revenue Reconciliation Act of 1993

We investigate the capitalization of shareholder-level taxes into stock values and provide evidence that capitalization of dividend taxes is influenced both by dividend policy and institutional ownership. We regress weekly abnormal stock returns surrounding the passage of the Revenue Reconciliation Act of 1993 on firm dividend yield, institutional ownership, and control variables. We document a negative stock price reaction conditioned on dividend yield during the two weeks in August, 1993, that Congress passed and President Clinton signed legislation that increased individual income tax rates. In addition, we find that the level of institutional holdings, which proxies for whether the marginal investor in a particular stock is an individual taxpayer, moderates this negative stock price reaction. These findings demonstrate that dividend tax capitalization depends upon both the expected dividend policy of the firm and the tax status of the marginal investor.

'Read My Lips...': Does the Tax Rhetoric of Presidential Candidates Affect Security Prices?

We investigate whether security prices reflect the tax rhetoric of opposing candidates during the 1992 U.S. Presidential campaign. We use daily data from the Iowa Political Stock Market to measure changes in the likelihood that the candidate advocating an increase in individual income tax rates would be elected. To isolate the effect of tax rhetoric, we examine the relations between changes in election likelihood and (a) changes in the implicit tax rate on tax-exempt bonds and (b) daily abnormal returns to dividend-yielding stocks. We find that the implicit tax rate on tax-exempt bonds increases as the election probability of the candidate advocating the tax rate increase rises. Consistent with this finding, we also report that abnormal returns for dividend-yielding stocks are negatively associated with changes in the election probability of the candidate advocating a tax increase. Moreover, this negative association decreases with the level of institutional stockholdings, a proxy for the likelihood that the marginal investor in a particular stock is not an individual. In sum, these findings suggest that security prices reflect the expected changes in future tax policy implicit in the tax rhetoric of presidential candidates as the political fortunes of the candidates change throughout the campaign.

The Effects of Supervisory Advice on Tax Professionals’ Information Search Behaviors

Prior research provides evidence that, when searching for information to resolve client issues, tax professionals’ search processes are subject to confirmation bias. That is, their search tends to focus on information consistent with client preferences at the expense of attending to information that is contrary to client preferences. Although tax professionals are client advocates, such confirmation bias in information search is problematic because it may lead to systematic upward bias in assessments of the evidential support for client-preferred positions and to overly aggressive recommendations. In addition to their clients, tax staff professionals are also accountable to their supervisors. Therefore, this study investigates whether staff professionals’ confirmation bias in information search is influenced by their supervisors initial belief concerning whether the client-preferred tax position can or cannot be supported. We predict that confirmation bias will be stronger when the supervisors belief is consistent with client preference than when it is not. We report the results of an experiment in which 83 experienced tax professionals performed a simulated research task. We manipulated the clients preferred tax position and the supervisors initial belief in a 2×2 between-subjects design. Our results generally support our hypotheses in a case in which the client recognized a loss. However, when the client recognized a gain, the results do not support our hypotheses. We also find that measures of confirmation bias are positively associated with subordinates’ assessments of the evidential support for the client-preferred position and that evidential support assessments are positively associated with the strength of recommendations for the client-preferred position.