57 2.5.3.5 Interaction Effects: Tax Variables 58 10

We investigate whether acquiring firms attempt to increase their stock price prior to a stock for stock merger in order to reduce the cost of buying the target. In a sample of stock for stock mergers completed between 1985 and 1990, we find that acquiring firms manage earnings upward in the periods prior to the merger agreement. Our results also indicate that the degree of income increasing earnings management is positively related to the relative size of the merger.

Scholes et al. (2005) predict that S corporations, and other conduit entities such as partnerships and LLCs, can sell for a tax-driven purchase price premium relative to C corporations. We test this conjecture by comparing purchase price multiples in a sample of taxable stock acquisitions of S corporations to purchase price multiples for a matched set of taxable stock acquisitions of privately held C corporations. Consistent with Scholes et al.'s (2005) predictions, we find evidence that the organizational form of the target influences acquisition tax structure and acquisition price. Specifically, the evidence supports the conclusion that conduit entities (S corporations) fetch a taxbased purchase price premium relative to similar C corporations. Furthermore, our estimates indicate that average tax benefits in S corporation acquisitions are equal to approximately 12–17 percent of deal value.

We investigate the backdating of stock option exercises. Before SOX, we find evidence that some exercises were backdated to days with low stock prices. Consistent with a tax-based incentive, these suspect exercises are more likely when the personal tax savings from backdating are higher. However, suspect CEO exercises generate average (median) estimated tax savings of 96,000 (7,000). These savings appear modest relative to the costs insiders and firms face. We find that the likelihood of a suspect exercise increases in the likelihood of option grant backdating. This suggests that agency problems associated with backdating permeate option compensation in some firms.

Hybrid securities, Trust preferred stock, Financial reporting, Tax incentives

The purpose of this paper is to evaluate the model used by Harris and Kemsley (J. Acc. Res. 37 (1999) 275), Harris et al. (J. Public Econ. 79 (2001) 569) and Collins and Kemsley (Acc. Rev. 75 (2000) 405), hereafter CHHK, and to investigate their empirical results. We demonstrate that the model underlying CHHK is flawed, and show that their interpretation of the data is incorrect. Finally, we find that after controlling for market to book ratio, Harris and Kemsley's first main result vanishes. In total, we reject CHHK's conclusions that equity prices are discounted for shareholder dividend taxes on retained earnings.

ABSTRACT: This paper examines the implications of tax loss carryback incentives for corporate reporting decisions and capital market behavior. During the 1981 through 2010 sample period, we find that firms increase losses in order to claim a cash refund of recent tax payments before the option to do so expires, and we estimate that firms with tax refund-based incentives accelerate about $64.7 billion in losses. Tax-motivated loss shifting is reflected in both recurring and nonrecurring items and is more evident for financially constrained firms. Analysts do not generally incorporate tax-motivated loss shifting into their earnings forecasts, resulting in more negative analyst forecast errors for firms with tax-based incentives than for firms without. Holding earnings surprises constant, however, investors react less negatively to losses reported by firms with tax loss carryback incentives. Data Availability: Data are available from sources identified in the paper.

We analyze a sample of firms accused of fraudulently overstating their earnings and examine the extent, if any, to which they paid additional income taxes on the allegedly fraudulent earnings. Based on restatements of current tax expense adjusted for the tax benefits of stock options, the evidence indicates that many firms included the overstated financial accounting income on their tax returns, thus overpaying their taxes in the process of inflating their accounting earnings. We estimate that the median firm sacrificed eight cents in additional income taxes per dollar of inflated pretax earnings. In aggregate, we estimate that the firms in our sample paid $320 million in taxes on overstated earnings of about $3.36 billion. These results indicate how far managers of firms are willing to go when allegedly inflating earnings.