Edward L. Maydew

Tax-induced earnings management by firms with net operating losses

This paper investigates tax-induced intertemporal income shifting by firms with net operating loss (NOL) carrybacks. For several years following the tax rate reductions of the Tax Reform Act of 1986 (TRA 86) these firms had incentives to shift recognition of revenues and expenses across years to increase their NOL carrybacks. By examining how NOL firms shift income and cross-sectional variation in the extent to which they do so, this research extends prior examinations of intertemporal income shifting by profitable firms (see Scholes, Wilson, and Wolfson [1992] and Guenther [1994]).1

Coveting Thy Neighbor?s Manufacturing: The Dilemma of State Income Apportionment

This paper investigates the economic impact of the apportionment formulae used to divide corporate income taxes among the states. Most apportionment formulae, by including payroll, turn the state corporate income tax at least partially into a payroll tax. Using panel data from 1978 - 1994, the results show that this distortion has an important effect on state-level employment. For the average state, reducing the payroll weight from one-third to one-quarter increases manufacturing employment around 3% and the result is highly robust. The results also indicate that apportionment changes have important negative externalities on other states in that the effects of the apportionment formula on aggregate employment is zero. Every job gained within a state from an apportionment change is taken from another state. This externality suggests that the U.S. would be better off if the apportionment formula were set at a federal level. The paper also shows that because the payroll component of the tax is administered on top of the existing payroll tax, the deadweight loss from this component of state corporate income taxation may be significant, despite the low tax rates.

Financial reporting, tax costs, and book-tax conformity

We investigate the role of book-tax conformity in firms financial reporting activities using a unique set of publicly traded firms that were forced to switch for tax purposes from the cash method to the accrual method. Prior to the mandated change, little tension existed between tax planning and financial reporting goals for these firms. After the change, recognition criteria for tax and financial reporting purposes became more alike, increasing the tension between financial reporting and tax objectives. Our results suggest that required use of the accrual method for tax purposes causes firms to slow their income recognition for financial statement purposes.

The Changing Role of Auditors in Corporate Tax Planning

This paper examines changes in the role that auditors play in corporate tax planning following recent events, including the well-known accounting scandals, passage of the Sarbanes-Oxley Act, and regulatory actions by the SEC and PCAOB. On the whole, these events have increased the sensitivity to and scrutiny of auditor independence. We examine the effects of these events on the market for tax planning, in particular the longstanding link between audit and tax services. While the effects are recent, they are already being seen in the data. Specifically, there has already been a dramatic shift in the market for tax planning away from obtaining tax planning services from ones auditor. We estimate that the ratio of tax fees to audit fees paid to the auditors of firms in the S&P 500 decline from approximately one in 2001 to one-fourth in 2004. At the same time, we find no evidence of a general decline in spending for tax services. In sum, the evidence indicates a decoupling of the longstanding link between audit and tax services, such that firms are shifting their purchase of tax services away from their auditor and towards other providers.

The impact of taxes on the choice of divestiture method

Abstract This paper estimates the magnitude of tax costs and their impact on the decision to divest assets via a taxable sale rather than a tax-free spin-off. We find that the tax costs are substantial, averaging 8% of market value of the divested assets, and that cross-sectional variation in tax costs has a large impact on managers’ choice of divestiture method. Our results are consistent with two explanations. First, managers are willing to incur avoidable tax costs to gain earnings and cash flow benefits. Second, managers choose taxable sales because the acquisition premia on the sales exceed the avoidable tax costs.