Mary Margaret Frank

Tax Reporting Aggressiveness and its Relation to Aggressive Financial Reporting

All authors are grateful to Thomson Financial for providing earnings forecast data, available through the Institutional Brokers Estimate System, as part of a broad academic program to encourage earnings expectations research. ABSTRACT: This study examines the relation between financial and tax reporting aggressiveness. Prior research has documented a growing gap between financial and taxable incomes since 1990. Over the same period, financial and tax regulators have documented an increase in tax shelter activity (aggressive tax reporting) and a concurrent increase in corporate accounting scandals (aggressive financial reporting). Consequently, this paper investigates whether the companies that engage in aggressive financial reporting are also the firms that engage in aggressive tax reporting. Our study is the first to predict and find that some firms tend to report aggressively for both book and tax purposes, while other firms tend to report more conservatively for both book and tax purposes. We use a system of equations to model the endogenous relation between financial and tax reporting decisions. The analysis controls for earnings management and tax planning incentives, and for rule differences between GAAP and tax law. Our bivariate and multivariate results both indicate firms that engage in aggressive financial reporting also engage in aggressive tax reporting. These results are important to both financial and tax regulators, and other stakeholders, who have a vested interest in understanding the interaction of financial and tax reporting decisions. Data Availability: The data used in this study are publicly available from the sources indicated.

The Impact of Taxes on Corporate Defined Benefit Plan Asset Allocation

This paper investigates the extent to which taxes affect a corporation’s decision to allocate its defined benefit plan’s assets between equity and bonds. Prior theoretical research shows that if a corporation integrates its financial policy and pension investment policy, differences in tax rates create an arbitrage opportunity. The firm’s tax benefits from the arbitrage should be positively related to the percentage of its pension assets allocated to bonds. Consistent with this prediction, but contrary to prior empirical work, this paper finds firms’ tax benefits are positively and significantly associated with the percentage of their pension assets invested in bonds.

Are shareholder dividend taxes on corporate retained earnings impounded in equity prices? Additional evidence and analysis

Recently, several studies have concluded that individual investor level dividend taxes on corporate retained earnings are impounded in common stock prices, independent of the timing of dividend payments. We show that the model underlying these studies is internally inconsistent. We also discuss why the model of dividend tax capitalization described in these recent studies is not likely to be descriptive of the taxation of corporate distributions, and we present several reasons, with corroborating data, to believe that common stock prices are not affected by dividend taxes in the manner articulated in these studies. Our empirical results can be summarized as follows. We replicate some of the basic results of prior dividend capitalization studies. We test for evidence of dividend tax capitalization around tax rate changes resulting from the ERTA81, the TRA86 and the OBRA93. Using the same methodology employed in recent research, the evidence does not support dividend tax capitalization across the three tax regimes. We also perform numerous additional data analyses that in general produce results that do not support the conclusions of recent dividend tax capitalization studies. Finally, we find that after controlling for market to book ratios, the main results in prior studies vanish. Overall, the analyses and evidence in this study indicate that shareholder dividend taxes on corporate retained earnings are not impounded in stock prices.

Tax Avoidance at Public Corporations Driven by Shareholder Taxes: Evidence from Changes in Dividend Tax Policy

We exploit exogenous changes in a country’s shareholder dividend tax policy to quantify the impact shareholder demand has on corporate tax avoidance by managers of public corporations. Specifically, we examine changes in corporate tax avoidance after the elimination, as well as enhancement, of imputation systems using a difference-in-difference design. We estimate shareholder demand contributes to an increase in corporate tax avoidance of approximately 10% of pre-tax income upon elimination of the imputations systems, which reflects a decrease of 30% from the corporate statutory tax rate for the average public corporation.In a complementary country-level analysis, we find aggregate corporate tax revenues decreased after the elimination of the imputation systems, consistent with an increase in corporate tax avoidance. The analysis of the cross-sectional variation in our difference-in-difference results provides evidence that the incentive for managers to engage in corporate tax avoidance to benefit shareholders varies by public corporations’ foreign operations and ownership concentration. Our findings also inform the debates over tax reform in various countries and have implications for future international studies in a variety of disciplines including financial accounting and finance.

Mountain or Molehill? The Pervasiveness of Overstated Earnings Through the Expected Rate of Return on Defined Benefit Pension Plan Assets

Using a sample of firms over the period of 1991 through 2005, we examine the expected rate of return (ERR) assumption associated with defined benefit pension plans. The evidence suggests that contrary to suggestions in the business press, the ERR is not overstated relative to several benchmarks including contemporaneous actual returns, historical cumulative actual returns and expected future returns based on asset allocation within the pension. We also find that changes in the ERR are infrequent, typically have less than a 1% impact on operating income and are positively related to differences between estimated and actual ERRs. When we examine firms with the highest ERRs or with the most opportunity to inflate earnings, we find they are no more likely to boost earnings through the ERR than other firms. We conclude that the evidence suggests overstated earnings through the ERR is not pervasive or material, which helps regulators assess the costs and benefits of eliminating this discretion in financial reporting.