Lillian F. Mills

Last Chance Earnings Management: Using the Tax Expense to Meet Analysts' Forecasts

We assert that the tax expense is a powerful context in which to study earnings management, because it is one of the last accounts closed prior to earnings announcements. Although many pre-tax accruals must be posted in the year-end general ledger, managers estimate and negotiate tax expense with their auditors immediately prior to earnings announcements. We hypothesize that changes from third- to fourth-quarter effective tax rates (ETRs) are negatively related to whether and how much a firm’s earnings absent tax expense management miss analysts’ consensus forecast, a proxy for target earnings. We measure earnings absent tax expense management as actual pre-tax earnings adjusted for the annual ETR reported at the third quarter. We provide robust evidence that firms lower their projected ETRs when they miss the consensus forecast, which is consistent with firms decreasing their tax expense if non-tax sources of earnings management are insufficient to achieve targets. We also find that firms that exceed earnings targets increase their ETR, but this effect is less significant. By studying the tax expense in total, rather than narrow components of deferred tax expense, our results provide general evidence that reported taxes are used to manage earnings.

Using tax return data to simulate corporate marginal tax rates

We document that simulated corporate marginal tax rates based on financial statement data (Shevlin 1990 and Graham 1996a) are highly correlated with simulated rates based on corporate tax return data. We provide algorithms that can be used to estimate the book or tax simulated rates when they are not available. We find that the simulated book marginal tax rate does a better job of explaining financial statement debt ratios than does the analogous tax return variable and discuss how the book simulated rate is likely to be an appropriate measure in settings with global, long-term considerations.

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.

Military Experience and Corporate Tax Avoidance

We find that managers with military experience pursue less tax avoidance than other managers and pay an estimated

The Tradeoffs between Tax Savings and Financial Reporting Costs: Public versus Private Firms in China

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Forecasting Tax Expense: New Evidence from Analysts

2 million more in corporate taxes per firm-year. These managers also undertake less aggressive tax planning strategies with smaller tax reserves and fewer tax havens. Although they leave tax money on the table, boards hiring these managers benefit from reductions in other gray areas in corporate reporting. The broad implications are as follows: for employee selection, boards can consider employees’ personal characteristics as a control mechanism when outputs are difficult to contract ex ante or measure ex post.

Does FIN 48 Improve Firms' Estimates of Tax Reserves?

This study examines how public and private firms responded to the 2008 tax rate reduction in China from 33 percent to 25 percent. We find that private firms report significantly more income-decreasing accruals than public firms in 2007, prior to the tax rate reduction. These negative accruals are substantial and material both compared to public firms and compared to 2008. Private firms appeared to shift RMB 8 million in the aggregate, or 22 percent of total income. The results provide the first economy-wide estimates of the extent to which private firms respond materially to rate changes with inter-temporal income-shifting.

Do Financial Gatekeepers Under-Protect Investors? Evidence from Criminal Background Checks

Using recently available pre-tax earnings forecast data from 2003 to 2012, we infer analysts’ income tax expense and effective tax rate (ETR) forecasts and provide the first large-sample evidence on their dispersion and accuracy. Even though managers provide annual ETR estimates each interim quarter, management’s estimates are not equal in information content and analysts do not merely mimic these estimates, consistent with analysts providing incremental information. Analysts’ forecasts are more disperse and less accurate when management’s interim ETR estimate include discrete items, consistent with more uncertainty and greater difficulty in understanding the tax environment when accounting standards require exceptions to the integral method. Taken together, our results suggest management interim ETR estimates are critical to the market’s understanding of tax expense.

Implicit Corporate Taxes and Income Shifting

This paper examines whether the increased accounting guidance and reporting requirements of FIN 48 impact the adequacy and accuracy of tax reserves and the effect of auditor-provided tax services on tax reserves. While we do not find FIN 48 affected the adequacy or accuracy of tax reserves on average, FIN 48 eliminated the differences in the tax reserve adequacy of firms with and without auditor-provided tax services that existed prior to its adoption. We also find evidence of more timely recording and less premature releasing of tax reserves post-FIN 48. Our evidence is consistent with an increase in comparability of reserves for firms that do and do not purchase auditor-provided tax services, consistent with one of the FASB’s objectives for FIN 48.

Book-Tax Differences and Internal Revenue Service Adjustments

We examine whether financial advisors with pre-advisor criminal records pose a greater risk to investors than those without. We find that financial advisors with pre-advisor criminal records are more likely to receive future customer complaints. Their complaints are more likely to receive arbitration awards or settlements and are more likely to involve large settlements exceeding