Firm and Investor Responses to Uncertain Tax Benefit Disclosure Requirements

Abstract

We examine whether proprietary costs affect disclosure quality and how investors react to disclosure quality in a new proprietary cost setting. We apply Verrecchia's (1983) proprietary cost theory to the FIN 48 adoption setting and argue that proprietary costs result from beliefs that the new disclosures could weaken a firm's competitive position when negotiating with tax authorities. FIN 48 is an ideal setting to examine how proprietary costs affect disclosure given the proprietary nature of uncertain tax positions, and the ability to construct objective measures of both proprietary costs and disclosure quality. We construct disclosure quality scores for S&P 1500 firms and offer two empirical findings. First, we find a negative association between proprietary costs and disclosure quality. Second, investors reward firms for low disclosure quality, especially small firms and firms with high proprietary costs. Both findings are consistent with Verrecchia's (1983) theory, and suggest that proprietary costs moderate investor demand for full disclosure. JEL Classifications: G14, L15, M41, M44, M45

Integrated Thinking and the Transparency of Tax Disclosures in the Corporate Reports of Firms

“…On the other hand, integrated thinking could increase managers’ awareness of maximizing firm value resulting in increased tax avoidance strategies with tax transparency disclosure used as a strategy to improve societal legitimacy or to conceal tax avoidance behavior (concealing argument). The latter argument is consistent with Robinson and Schmidt () who find that proprietary costs of the disclosure about uncertain tax positions in the United States in accordance with FIN 48 (as measured by tax avoidance proxies) are associated with lower quality FIN 48 disclosures. Similarly, Hope et al.…”

Uncertain tax benefits, international tax risk, and audit specialization: Evidence from US multinational firms

“…Third, this study is also timely because there are a number of audit implications stemming from large or abnormal UTB estimates and reporting requirements. For example, the link between financial reporting and tax reporting of UTBs post implementation of the UTP reporting requirement from 2010 has placed more pressure on auditors in terms of identifying and evaluating potential tax uncertainties (Robinson & Schmidt, ). Finally, the findings of this study should be of interest to auditors, policymakers, regulators, and tax authorities (e.g., the IRS).…”

“…Recent studies explore the association between UTB estimates and tax aggressiveness (e.g., Lisowsky, ), the association between FIN48 disclosure requirements and tax aggressiveness (e.g., Robinson & Schmidt, ; Ciconte et al, ), and the association between UTB estimates and financial statement impacts, value‐relevance or informativeness, including cash flows, stock prices, earnings, and firm‐level risk (e.g., Gupta et al, ). Other studies on the subject of FIN48 have emphasized the considerable amount of judgment that management employs in the calculation of UTB estimates (e.g., De Simone & Stomberg, ).…”

Insights from Academic Participation in the FAF's Initial PIR: The PIR of FIN 48

“…Finally, studies that examine FIN 48 adoption disclosure practices (e.g., Robinson and Schmidt 2013) confirm that FIN 48 substantially increased information about tax uncertainty available in firms' financial statements. For instance, the authors document a 100 percent compliance rate with the requirement to disclose their tax reserve balance.…”