Knowledge that Transforms

Abstract This paper investigates whether economies of scale exist for tax planning. In particular, do larger, more profitable, multinational corporations avoid more taxes than other firms, resulting in lower effective tax rates? While the empirical results indicate that, ceteris paribus, larger corporations have higher effective tax rates, firms with greater pre‐tax income have lower effective tax rates. The negative relation between effective tax rates (ETRs) and pretax income is consistent with firms with greater pre‐tax income having more incentives and resources to engage in tax planning. Consistent with multinational corporations being able to avoid income taxes that domestic‐only companies cannot, I find that multinational corporations in general, and multinational corporations with more extensive foreign operations, have lower worldwide ETRs than other firms. Finally, in a sample of multinational corporations only, I find that higher levels of U.S. pre‐tax income are associated with lower U.S. and foreign ETRs, while higher levels of foreign pre‐tax income are associated with higher U.S. and foreign ETRs. Thus, large amounts of foreign income are associated with higher corporate tax burdens. Overall, I find substantial evidence of economies of scale to tax planning.

Abstract This study examines the association between audit committee characteristics and the ratio of nonaudit service (NAS) fees to audit fees, using data gathered under the Securities and Exchange Commission's (SEC's) fee disclosure rules. Issues related to NAS fees have been of concern to practitioners, regulators, and academics for a number of years. Prior research suggests that audit committees possessing certain characteristics are important participants in the process of managing the client‐auditor relationship. We hypothesize that audit committees that are independent and active financial monitors have incentives to limit NAS fees (relative to audit fees) paid to incumbent auditors, in an effort to enhance auditor independence in either appearance or fact. Our analysis using a sample of 538 firms indicates that audit committees comprised solely of independent directors meeting at least four times annually are significantly and negatively associated with the NAS fee ratio. This evidence is consistent with audit committee members perceiving a high level of NAS fees in a negative light and taking actions to decrease the NAS fee ratio.

Abstract Earnings from gold mining in Australia remained tax‐exempt for almost seven decades until January 1, 1991. In the early 1980s, rapid economic prosperity induced by escalated gold prices brought the Australian gold‐mining industry under intense political scrutiny. Using a variant of the modified Jones model, this paper provides evidence of significant downward earnings management by Australian gold‐mining firms, which is consistent with their attempts to mitigate political costs during the period from June 1985 to May 1988. In contrast, test of earnings management over a similar period in a control sample of Canadian gold‐mining firms produced insignificant results. Further, empirical results are robust to several sensitivity tests performed. During the period from June 1988 to December 1990, the Australian firms were found to have engaged in economic earnings management. This is consistent with the sample firms' incentive of maximizing economic earnings immediately prior to the introduction of income tax on gold mining. The findings of this study help to understand the impact of earnings management on the efficient resource allocation in an economy. They also contribute toward understanding the linkage between regulation of accounting for special purposes and general‐purpose financial reporting.

Abstract Several researchers (e.g., Lundholm 1999; Ryan 1997; Petroni, Ryan, and Wahlen 2000) have proposed a reporting mechanism to enhance the reliability of estimates and other forward‐looking information in financial reports. Their proposals require companies to report reconciliations of prior‐year estimates to actual realizations as supplemental information in their financial reports. Such disclosures would enable investors to distinguish between accurate and opportunistic reporting behavior, and, arguably, should create incentives for companies to estimate accurately in the first place. Our study provides evidence on these proposals. Specifically, we conduct two experiments within the context of an important intangible asset requiring estimation ‐ software development costs. Our results show that the proposed reporting mechanism is effective in communicating information about the accuracy of financial estimates. We find, however, that not all disclosures are equally useful. The most effective disclosures explicitly describe the implications of misestimation (if any) on both the balance sheet and on earnings, thereby reducing the computational complexity associated with less explicit disclosures. Furthermore, our results show that when the disclosures explicitly describe the implications of misestimation, investors reward accurate estimators but do not explicitly punish those who are inaccurate. We conclude that information about previous estimate accuracy is useful to investors and that regulators should consider the type of disclosure, because not all disclosures may be equally effective in creating management incentives for accurate estimation. Moreover, the competitive advantage conferred on firms that provide accurate estimates arguably should create incentives for all companies to estimate accurately in the future.

Abstract Asymmetric information between corporate insiders and other market participants can lead to large bid‐ask spreads or even a collapse of trade in financial markets. In this paper, we discuss how voluntary disclosure by insiders can remedy this problem. When insiders make disclosure decisions after they become informed, other market participants update their prior beliefs on the basis of both the information disclosed and the information not disclosed. Insiders then give up some or all of their information advantage to weakly increase their profits. These results do not rely on ex ante commitments on the part of the insiders.