Do Publicly Disclosed Tax Reserves Tell Us About Privately Disclosed Tax Shelter Activity?

We examine whether public disclosures of tax reserves recently made available through Financial Interpretation No. 48 (FIN 48) reflect corporate tax shelter activities. Understanding this relation is important to corporate stakeholders and researchers keen to infer the aggressive nature of a firm's tax positions from its tax reserve accrual. Our study links public disclosures of tax reserves with mandatory private disclosures of tax shelter participation as made to the Internal Revenue Service's Office of Tax Shelter Analysis. We find strong, robust evidence that the tax reserve is positively associated with tax shelters, while other commonly used measures of tax avoidance are not. Based on out‐of‐sample tests, we also show that the reserve is a suitable summary measure for predicting tax shelters. The tax benefits of tax shelters are economically significant, accounting for up to 48% of the aggregate FIN 48 tax reserves in our sample.     

Economic Growth and Financial Statement Verification

We use a proprietary data set of financial statements collected by banks to examine whether economic growth is related to the use of financial statement verification in debt financing. Exploiting the distinct economic growth and contraction patterns of the construction industry over the years 2002–2011, our estimates reveal that banks reduced their collection of unqualified audited financial statements from construction firms at nearly twice the rate of firms in other industries during the housing boom period before 2008. This reduction was most severe in the regions that experienced the most significant construction growth. These trends reversed during the subsequent housing crisis in 2008–2011 when construction activity contracted. Moreover, using bank‐ and firm‐level data, we find a strong negative (positive) relation between audited financial statements during the growth period, and subsequent loan losses (construction firm survival) during the contraction period. Collectively, our results reveal that macroeconomic fluctuations produce temporal shifts in the overall level of financial statement verification and temporal shifts in verification are related to bank loan portfolio quality and borrower performance.     

The Silent Majority: Private U.S. Firms and Financial Reporting Choices

This study uses a comprehensive panel of tax returns to examine the financial reporting choices of medium-to-large private U.S. firms, a setting that controls over $9 trillion in capital, vastly outnumbers public U.S. firms across all industries, yet has no financial reporting mandates. We find that nearly two-thirds of these firms do not produce audited GAAP financial statements. Guided by an agency theory framework, we find that size, ownership dispersion, external debt, and trade credit are positively associated with the choice to produce audited GAAP financial statements, while asset tangibility, age, and internal debt are generally negatively related to this choice. Our findings reveal that (1) equity capital and trade credit exhibit significant explanatory power, suggesting that the primary focus in the literature on debt is too narrow; (2) firm youth, growth, and R&D are positively associated with audited GAAP reporting, reflecting important monitoring roles of financial reporting; and (3) many firms violate standard explanations for financial reporting choices and substantial unexplained heterogeneity in financial reporting remains. We conclude by identifying opportunities for future research.     

Tax Aggressiveness and Accounting Fraud

There are competing arguments and mixed prior evidence on whether firms that are aggressive in their financial reporting exhibit more or less tax aggressiveness. Our research contributes to resolving this issue by examining the association between aggressive tax reporting and the incidence of alleged accounting fraud. Relying on several proxies for tax aggressiveness to triangulate our evidence, we generally find that tax aggressive U.S. public firms are less likely to commit accounting fraud. However, we caution that our results are sensitive to how tax aggressiveness is measured. More specifically, four (two) of the five (three) proxies for firms’ effective tax rates (book‐tax differences) load positively (negatively) during the 1981–2001 period, implying that fraud firms are less tax aggressiveness. Our inferences persist when we isolate the 1995–2001 period in which accounting impropriety steeply rose and corporate tax compliance steeply fell. Moreover, we continue to find that tax aggressive firms are less apt to fraudulently manipulate their financial statements when we apply factor analysis to identify tax avoidance with a common factor extracted from the underlying proxies and match on propensity scores to ensure that the fraud and nonfraud samples have very similar nontax characteristics.