Ryan J. Wilson

A New Measure of Accounting Quality

This study develops a measure of accounting quality based on audit fees. Adopting a neoclassical view of the audit market, we argue that unexplained audit fees should contain information about accounting quality. We find that our measure of unexplained audit fees correlates positively with other empirical measures of quality. We further show that our measure of accounting quality is incrementally predictive of fraud, restatements, and SEC comment letters, controlling for other measures of quality. Overall, we believe that the information in audit fees can be used to provide an alternative measure of a firm’s accounting quality.

Dual Class Ownership and Tax Avoidance

This study investigates whether the agency conflicts inherent in a dual class ownership structure are associated with the level of firms’ tax avoidance. Dual class ownership presents a unique agency problem because insiders’ voting rights (i.e., insiders’ ability to control the firm) exceed their cash flow rights (i.e., insiders’ claim on the cash payouts of the firm). Thus, insiders control a majority of the votes of a firm despite having claims to a minority of the firm’s cash flows. We examine the levels of non-conforming and conforming tax avoidance for a sample of dual class firms. Among dual class firms, we find that the extent of non-conforming tax avoidance is declining as the difference between voting rights and cash flow rights increases. In addition, we find that the difference between voting rights and cash flow rights is associated with lower levels of conforming tax planning among dual class firms. We also compare the level of tax avoidance of dual class firms to other publicly traded firms and find that dual class firms engage in lower levels of non-conforming and conforming tax planning. These findings are consistent with the quiet life view, which suggests that when managers are insulated from takeover they avoid the costly effort associated with increased tax planning activities.

Did FIN 48 Limit the Use of Tax Reserves as a Tool for Earnings Management

We utilize new income tax reserve disclosures required under FIN 48 to examine whether managers use discretion over this accrual to manage earnings to meet the consensus analyst forecast. We find that firms with pre-managed earnings (i.e., earnings before the change in the tax reserve) that are below the consensus analyst forecast are far more likely to reduce their tax reserves and thus report higher net income. In fact, we find that 37 percent of firm-years with pre-managed earnings below the consensus forecast meet the forecast when the change in the tax reserve is included in earnings. In contrast, only 9.8 percent of firm-years with pre-managed earnings above the consensus forecast increased their tax reserves to the extent that it caused them to miss the consensus forecast. This asymmetric result is consistent with managers using their discretion over tax reserves to meet consensus analyst forecasts. Using a proxy for changes in tax reserves developed by Blouin and Tuna (2007), we also document a decline in the use of tax reserves to meet the consensus analyst forecast following the adoption of FIN 48. Nonetheless, our results using both estimated and actual changes in tax reserves clearly suggest that managers continue to use their discretion over this account to meet the consensus analyst forecast, although at a lower rate of recurrence than during the pre-FIN 48 time period.

Conforming Tax Avoidance and Capital Market Pressure

In this study we develop a measure of corporate tax avoidance that reduces both financial and taxable income, which we refer to as “book-tax conforming�? tax avoidance. We use simulation analyses, LIFO/FIFO inventory method conversions, and samples of private and public firms, to validate our measure of conforming tax avoidance. We then investigate the prevalence of conforming tax avoidance within a sample of public firms. Results from the validation tests indicate that our measure of conforming tax avoidance successfully captures book-tax conforming transactions and thus, variation in conforming tax avoidance across firms. Consistent with expectations, we also find that the extent to which public firms engage in conforming tax avoidance varies systematically with the capital market pressures to which they are subject. For example, public firms that lack analyst following, do not issue equity securities, report lower sales growth, or smaller discretionary accruals engage in relatively more conforming tax avoidance and less nonconforming tax avoidance. Our study develops a new measure of conforming tax avoidance that should be useful in future research and provides new insights on the extent to which public firms are willing to reduce income tax liabilities at the expense of reporting lower financial income.

The effect of tax-motivated income shifting on information asymmetry

We examine whether tax-motivated income shifting by U.S. multinational corporations affects information asymmetry. Using a new firm-year measure of income shifting and a two-stage least squares approach, we find income shifting is positively associated with four measures of information asymmetry. Cross-sectional tests reveal that this effect is more pronounced for firms with large differences between foreign and domestic earnings growth. Using SFAS 131 to improve identification and establish evidence consistent with a causal relation between income shifting and information asymmetry, we demonstrate that the adverse impact of income shifting on information asymmetry is concentrated in firms that discontinue geographic earnings disclosures. Overall, our study provides evidence that significant consequences of information asymmetry are associated with tax-motivated income shifting.

How Do Reductions in Foreign Country Corporate Tax Rates Affect U.S. Domestic Manufacturing Firms

We examine whether reductions in foreign country statutory corporate tax rates affect the competitive environment of U.S. domestic manufacturing firms and how U.S. firms respond. We develop a measure of U.S. domestic firms’ exposure to changes in foreign country corporate tax rates and find U.S. domestic firms’ profitability is adversely affected by decreases in foreign country corporate tax rates, consistent with intensified competition. We find U.S. domestic firms respond by increasing investment in research and development and capital expenditures and by improving total factor productivity. In cross-sectional analyses, we find the impact of foreign tax cuts is concentrated among U.S. domestic firms with low product differentiation. Taken together, these findings suggest that reductions in foreign country statutory corporate tax rates escalate competition faced by U.S. domestic firms, and in response U.S. domestic firms increase investment and become more productive.

Political Costs and Corporate Tax Planning: Evidence from Sin Firms

The products and services of firms operating in sin industries (alcohol, tobacco, gaming, and firearms) run contrary to social norms and can produce significant negative externalities for society. As such, sin firms are at greater risk of incurring political costs in the form of additional regulation, higher taxes, or capital market intervention if they come under scrutiny for their tax avoidance practices. Because of the nature of their products, regulators and policymakers are likely to face less pushback imposing new regulations or taxes on these firms. Consequently, we hypothesize and find that sin firms exhibit less tax avoidance than non-sin firms, particularly through uncertain and more risky tax avoidance strategies. The negative relationship between the sin firm status and tax avoidance is less pronounced in U.S. firms that accumulate political capital via intensive lobbying activities, or face more financial constraints, and less pronounced in countries where people are more receptive to “sin” products. Exploiting changes in partisan control of the Congress and the White House, difference-in-differences tests show that firearm firms engage in less (more) tax avoidance when the Democrats (Republican) control both the Congress and White House. Overall, we conclude that greater exposure to political costs leads to less tax avoidance for sin firms.

Who Invests in Corporate Tax Avoiders

We use data on individual investors’ stock holdings and retail trades to investigate whether corporate tax avoidance affects the willingness of individual investors to own stock. Consistent with corporate tax avoidance increasing the perceived risk of owning stock and the costs of processing financial information, we provide evidence that individual investors own less stock of firms that avoid more taxes and report more uncertain tax positions. We then examine whether investor sophistication and investment strategies impact individuals’ willingness to own stock in these firms. Our results suggest that more sophisticated investors and investors with shorter investment horizons own more stock in high tax avoidance firms, while more conservative investors own less. Overall, our findings are consistent with significant variation in how individual investors perceive corporate tax avoidance.

The Effect of Income Shifting on the Information Environment: Evidence from Two-Stage Least Squares and SFAS 131

We examine whether tax-motivated income shifting by U.S. multinational corporations affects information asymmetry. Using a new firm-year measure of income shifting and a two-stage least squares approach, we find income shifting is positively associated with four measures of information asymmetry. Cross-sectional tests reveal that this effect is more pronounced for firms with large differences between foreign and domestic earnings growth. Using SFAS 131 to improve identification and establish evidence consistent with a causal relation between income shifting and information asymmetry, we demonstrate that the adverse impact of income shifting on information asymmetry is concentrated in firms that discontinue geographic earnings disclosures. Overall, our study provides evidence that significant consequences of information asymmetry are associated with tax-motivated income shifting.

Is the Market Grossed out by Gross-Ups? An Investigation of Firms that Pay Their CEOs' Taxes

This study provides evidence on whether investors value tax gross-up provisions for executives, and how the elimination of these provisions changes executive compensation. We examine the market response to tax gross-up eliminations and find investors react favorably to the removal of these provisions, suggesting that on average, investors perceived these agreements as a bad compensation practice that destroyed firm value. Next, we examine whether firms respond to these eliminations by increasing other forms of executive compensation. We find firms eliminating tax gross-up provisions increase bonus but not salary. Broadly, we provide evidence that some features of compensation contracts are not valued by shareholders, and that the elimination of these features can lead to increased firm value.