This study documents one effect of the theory of implicit taxes, providing evidence that a change in the tax rate results in a change in pre-tax returns. Yield spreads of pairs of Treasury bills maturing in the last week of December and the first week of January are examined. Year-ends not affected by rate changes show a significant positive yield spread between these pairs of bills, reflecting an upward-sloping yield curve. However, for year-ends coinciding with the tax rate reductions of 1981 and 1986 there is a significant negative yield spread between these pairs of bills.

[This study investigates whether accounting earnings of U.S. corporations are managed in response to changes in the statutory corporate income tax rate. The Tax Reform Act of 1986 (TRA) reduced the maximum corporate tax rate from 46 percent to 34 percent. If managers attempt to maximize firm value by minimizing tax costs, this tax rate change would have provided a substantial incentive to defer income. The motivation for this study comes from attempts by previous researchers to identify situations in which incentives to manage earnings exist and to find empirical evidence of such management (Healy 1985; DeAngelo 1986; Liberty and Zimmerman 1986; McNichols and Wilson 1988; Jones 1991; Cahan 1992). Evidence of earnings management is examined by focusing on accounting accruals. As pointed out by Manzon (1992) and Choi et al. (1991), total accruals can be separated into those types of accruals that are not expected to have a significant effect on taxable income (called "non-current accruals," e.g., depreciation) and those types of accruals that are expected to affect taxable income (called "current accruals," e.g., accounts receivable, accrued payables). By knowing exante which types of accruals are most likely to affect tax savings, more powerful tests of tax motivated earnings management are possible. Firms expected to reduce financial statement income to achieve tax savings are large firms, firms with low levels of long-term debt, and firms with high levels of manager ownership. While the reduction in corporate tax rates provided an incentive for managers to decrease financial statement income in the year prior to the effective date of TRA, other incentives might make it costly for managers to do so. For this reason, many firms may choose to forego a current tax savings to avoid reducing financial statement net income. The results of empirical tests report significantly lower current accruals for large firms for the year prior to the tax rate reduction.1 As predicted, these accruals are positively associated with levels of long-term debt. There is no relation between accruals and manager ownership. Accruals for large firms with years ending 30 June are not lower than those of calendar year firms. This study provides evidence of management of financial statement income in response to a large decrease in the statutory corporate tax rate. The results have implications for independent auditors, who face conflicting incentives to (1) provide clients with tax minimization advice, and (2) detect material cases of client earnings management. The results are also expected to be of interest to tax policy decision makers, since the ability of corporate managers to engage in tax rate arbitrage through earnings management can affect revenue estimates, as well as estimates of effects of tax law changes.]

Investigates whether accounting earnings of American corporations are managed in response to changes in the statutory corporate income tax rate brought about by the Tax Reform Act of 1986 (TRA). Reducing the maximum corporate tax rate from 46% to 34% through TRA; Concept of earnings management in relation to tax rate reductions in the TRA.

[Much of the research in positive accounting theory deals with whether managers choose accounting methods that reduce or minimize certain costs faced by firms, such as the cost of violating bond covenant restrictions, political costs, and the tax cost associated with the use of the FIFO rather than the LIFO inventory method. However, this research ignores some more fundamental costs associated with the legal form under which the firm chooses to operate, a much larger issue that precedes the choice of accounting methods. This article examines this larger issue by focusing on the trade-off that exists between tax costs and transaction costs in the choice of organizational form. Scholes and Wolfson (1986, 1989) assert that an organization's form is chosen to minimize both tax costs and transaction costs. Under this theory, if the corporate form has a greater tax cost than that of an alternative form, the partnership, the corporate form would not be chosen unless the transaction costs of the partnership form exceed those of the corporate form. Fama and Jensen (1983b, 327) examine costs of alternative organizational forms and state that "the form of organization that survives in an activity is the one that delivers the product demanded by customers at the lowest price while covering costs." Although Fama and Jensen specifically excluded tax costs from their analysis, Scholes and Wolfson argue that both relative tax costs and relative transaction costs are important determinants of organizational form choice, and that changes in relative tax costs will result in changes in form. They also make the following predictions about the effect of the 1986 Tax Reform Act: corporations will be replaced as an organizational form by partnerships for new ventures financed with equity; many existing corporations will convert to partnership form; absent this conversion, many corporations will add debt to their capital structure. These predictions lead directly to two questions. First, how do tax laws affect the choice of business entity? Second, what happens when these tax laws change? These two general questions are investigated here through two more specific research questions. The first is, What are the incremental tax costs and transaction costs of alternative organizational forms (corporations and master limited partnerships) available to large, publicly traded firms? The second is, How will managers of existing corporations respond to a tax law change (the 1981 Economic Recovery Tax Act) that causes the tax cost of the corporate form to increase relative to that of the partnership form? The results of empirical tests of four hypotheses developed to investigate these research questions indicate that, for the period 1978-85, the corporate form resulted in a significantly greater average tax cost than the partnership form, and this incremental tax cost increased significantly after the 1981 Economic Recovery Tax Act (ERTA). Partnerships are found to have a significantly lower return on assets and sales than a matched sample of corporations. Responses of managers to increasing tax costs of the corporate form after 1981 are predicted to be (1) increasing long-term debt, (2) increasing non-dividend distributions, and (3) decreasing dividend payout ratios. Empirical results for both univariate and multivariate tests are consistent with these predictions. These results make a significant contribution to accounting research for two reasons. First, they demonstrate a relationship between changes in relative tax costs of alternative (competing) organizational forms and changes in such fundamental elements of capital structure as debt levels, non-dividend distributions, and dividend payout ratios. Previous research on the relationship between taxes and capital structure (e.g., Bradley et al. 1984; DeAngelo and Masulis 1980; MacKie-Mason 1990; Titman and Wessles 1988) has not considered the effect of the tax cost of alternative organizational forms. Second, the results provide empirical support for predictions by Scholes and Wolfson (1986, 1989) and Petruzzi (1988) regarding responses of corporations to increases in relative tax costs (i.e., Scholes and Wolfson predict increasing long-term debt; Petruzzi predicts increasing non-dividend distributions).]

We investigate how cross-country differences in financial accounting standards affect the relation between financial accounting earnings and real economic value-relevant events that underlie those earnings. Based on previous research and economic theory we hypothesize that, because of differences in legal systems and the demand for accounting information, differences in legal protection for external shareholders, and differences in the degree of tax conformity in our sample countries, accounting earnings in the UK and the US will be more closely related to underlying economic activity than will accounting earnings in France and Germany. Empirical results are generally consistent with our hypothesis.

We examine whether differences in international capital mobility across countries are related to country‐specific differences in financial reporting environments. We hypothesize that countries where financial accounting environments lead to greater disclosure of value‐relevant accounting information are more likely to have higher international capital mobility. The results of empirical tests are consistent with our hypothesis.

Differences between SIC codes assigned to companies by COMPUSTAT and CRSP are examined. Large differences are observed at two-, three-, and four-digit levels. Correlations of intra-industry monthly stock returns are larger, and variances of intra-industry financial ratios are smaller for industries based on COMPUSTAT codes. Replication of a portion of Freeman and Tse (1992) produces significant results using COMPUSTAT codes, consistent with the original research, but insignificant results for CRSP codes.

A valuation approach is used to examine the effect of the LIFO inventory method on the relation between the market value of a firm's stock and the book value of equity. The paper develops three competing hypotheses that have different predictions regarding the relation between the LIFO reserve and the market value of equity. Results indicate a significant negative relation between the LIFO reserve and the value of equity, inconsistent with the pricing of LIFO reserves as unbooked assets, but consistent with a model that views the LIFO reserve as a measure of the effect of increases in factor input prices on firm value. Résumé. Les auteurs ont recours à une évaluation pour examiner l'incidence de la méthode DEPS de détermination du coût des stocks sur la relation entre le cours de l'action d'une société et sa valeur comptable. Ils élaborent trois hypothèses concurrentes qui débouchent sur des prédictions différentes en ce qui a trait à la relation entre la réserve résultant de l'utilisation de la méthode DEPS et la valeur marchande de l'entreprise. Les résultats indiquent une relation négative significative entre cette réserve et la valeur comptable de l'entreprise, relation qui ne concorde pas avec le prix de ladite réserve que l'on voudrait assimiler à un actif non comptabilisé, mais qui cadre avec un modèle selon lequel la réserve résultant de l'utilisation de la méthode DEPS est considérée comme une mesure de l'incidence des hausses du prix des intrants sur la valeur de l'entreprise.

We investigate how shareholder-level taxes are capitalized into stock prices using a model that incorporates the investment and payout decisions of a firm and the investment alternatives available to investors. Shareholder taxes affect stock prices both indirectly, via the effect of taxes on corporate investment decisions, and directly, by reducing both the mean and variance of after-tax returns. In our model, tax capitalization is not eliminated by the presence of tax-exempt investors, does not depend on whether equity is composed of contributed capital or retained earnings, and does not depend on the tax rate faced by a hypothetical marginal investor.

Lee (1988) finds that LIFO firms have higher earnings‐price (EP) ratios than non‐LIFO firms despite the income‐reducing effects of LIFO, a result contrary to economic intuition that Lee describes as a “puzzle.” This paper attempts to resolve this puzzle by introducing refined measures of variables that are related to both EP ratios and inventory costing method choices. The improved proxies are analysts' expectations of future growth rather than realized growth, beta computed using a procedure designed to reduce measurement error rather than the usual OLS beta, and leverage as a supplemental risk measure. Further, we control for expected earnings changes, since transitory earnings shocks that are not expected to persist in future earnings affect the numerator of the EP ratio. After controlling for these factors, we find that EP ratios for LIFO firms are actually lower than those of non‐LIFO firms, a result consistent with economic intuition and the result expected by Lee.