Tax-related mandatory risk factor disclosures, future profitability, and stock returns

On the Determinants and Effects of Corporate Tax Transparency: Review of an Emerging Literature

“…Consistent with the results of Campbell et al (2019) and Blaufus et al (2019), investors seem to reward news about tax avoidance activities associated with low (legal) risks. However, MNEs explicitly mentioned in media reports about Lux Leaks experience less favorable reactions, suggesting that the benefits can be neutralized by negative consequences of increased public scrutiny (in line with the cross-sectional findings of Brooks et al, 2016).…”

“…Robinson et al (2016) document that investors are not able to identify firms which are particularly over-reserved and do not seem to incorporate this information in their stock price valuation. 60 Finally, Campbell et al (2019) provide evidence that the extent of tax-related risk factor disclosures in a firm's 10-K filing is positively associated with contemporaneous stock returns. Taken together with the results on their informativeness about future 59 As described in Section 4.3, evidence suggests that firms systematically reduced the UTB amounts recorded in their financial statements and simultaneously increased the qualitative UTB disclosures in the tax footnotes following the introduction of Schedule UTP.…”

“…As of 2005, the SEC requires firms to discuss significant risk factors in their 10-K filings (Item 1A). Campbell et al (2019) measure the extent of firms' tax-related risk factor disclosures and find a negative association with future cash tax payments. They conclude that the tax risks discussed by managers reflect positions of reasonable risk-taking (i.e., which are value-increasing as they result in positive future net cash flows).…”

“…In light of the limitations of quantitative disclosures and due to the advance of textual analysis techniques, research has recently started examining qualitative tax disclosures as an additional source of information on tax behavior. For example, Campbell et al (2019) analyze tax-related risk factor disclosures of public US firms. As of 2005, the SEC requires firms to discuss significant risk factors in their 10-K filings (Item 1A).…”

Risk Factor Disclosures: A Review and Directions for Future Research*

“…The study shows that firms with more risks disclose more risk factors and that the types of risk firms face determine the extent to which they disclose risks. Informativeness of RFDs in predicting future cash flows and firm value was also confirmed by Campbell et al (2019). The study provides evidence that tax risk disclosure signals an increase in cash flow through a decrease in future cash taxes paid and that investors value the information in tax risk disclosure.…”