Abstract. Manufacturing firms can manipulate income by producing in excess of the quantity needed to meet current period demand, thereby allocating part of current period fixed manufacturing overhead costs from cost of goods sold to inventory. Because it is subject to manipulation, the component of earnings due to producing in excess of sales may be of lower quality than the remaining component of earnings. We investigate this possibility using a regression of security returns on unexpected income and an estimate of the change in percent of production added to inventory ( CPAI ). An analytical model indicates that CPAI determines the “earnings surprise” subject to manipulation by overproducing. Assuming the market recognizes this, the coefficient on CPAI should be negative because this low quality component must be deducted from the total “good news” conveyed by the change in reported earnings. Alternatively, CPAI may convey good or bad news to the market that is unrelated to the manipulation of current period earnings. Firms may increase the percent of production added to inventory in anticipation of high levels of future sales. In this case, the estimated coefficient on CPAI should be positive. Or, if the increase in the percent of production added to inventory reflects anticipation of a strike or an unexpected downturn in current sales, the estimated coefficient should be negative. Cross‐sectional tests using a large sample of manufacturing firms indicate a significant positive relation between security returns and CPAI. This finding is consistent with market participants viewing CPAI as a leading indicator of firm performance. Although the results are most supportive of CPAI conveying good news, there is some evidence that CPAI is used by managers to smooth earnings and, for firms classified as smoothing earnings, there is weak evidence that the component of earnings related to CPAI is viewed by market participants to be of lower quality.

We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers' educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities.

Steve Matsunaga, Terry Shevlin, D. Shores, Disqualifying Dispositions of Incentive Stock Options: Tax Benefits versus Financial Reporting Costs, Journal of Accounting Research, Vol. 30, Studies on Accounting and Taxation (1992), pp. 37-68

Using a sample of LIFO users, we examine the strengths and weaknesses of adopting a simultaneous equations approach to study managers' adjustments of interacting accounting measures that meet multiple objectives. We focus on the importance of considering differences in the costs and the effectiveness of adjusting accounting measures. In addition, we examine managers' objectives in subsequent years and how adjustments' reversals affect those objectives. Although generally consistent with earlier studies of LIFO inventory adjustments, our results indicate that modelling interacting accounting measures, such as other current accruals and depreciation, leads to differing conclusions about the role of taxes.

We examine whether executive stock options (ESOs) provide managers with incentives to invest in risky projects. For a sample of oil and gas producers, we examine whether the coefficient of variation of future cash flows from exploration activity (our proxy for exploration risk) increases with the sensitivity of the value of the CEO's options to stock return volatility (ESO risk incentives). Both ESO risk incentives and exploration risk are treated as endogenous variables by adopting a simultaneous equations approach. We find evidence that ESO risk incentives has a positive relation with future exploration risk taking. Additional tests indicate that ESO risk incentives exhibits a negative relation with oil price hedging in a system of equations where ESO risk incentives and hedging are allowed to be endogenously determined. Overall, our results are consistent with ESOs providing managers with incentives to mitigate risk-related incentive problems.

Harris and O'Brien (2018) investigate whether U.S. tax policy distorts U.S. multinationals’ (MNCs) investment. They find that MNCs facing higher repatriation tax costs engage in fewer domestic acquisitions. The study re-examines the results in two prior studies that found no effect (Hanlon et al. 2015) and a positive effect (Martin et al. 2015) by introducing a new proxy for repatriation tax costs: A binary variable for whether the MNC uses the Double Irish structure. We critique the theory underlying the prediction as well as the proxy. We conclude that caution should be exercised in taking the results at face value.

This paper traces the development of archival, microeconomic-based, empirical income tax research in accounting over the last 15 years. The paper details three major areas of research: (i) the coordination of tax and non-tax factors, (ii) the effects of taxes on asset prices, and (iii) the taxation of multijurisdictional (international and interstate) commerce. Methodological concerns of particular interest to this field also are discussed. The paper concludes with a discussion of possible directions for future research.

Abstract ABSTRACT: A common finding in the literature is that systematic post-announcement drifts in security returns are associated with the sign or magnitude of unexpected earnings changes. This paper examines proposed explanations for these drifts. The paper also documents that the systematic drifts in security returns are found for only a subset of earnings expectations models. For a class of expectations models based on the time series of reported quarterly earnings, variables coding (1) the sign and magnitude of the earnings forecast error and (2) firm size independently explain 81 percent and 61 percent, respectively, of the variation in post-announcement drifts. The joint explanatory power of (1) and (2) is 85 percent, indicating that the effect of these two variables is highly collinear. The drifts are a persistent phenomenon over the 1974 to 1981 period with no evidence of being concentrated in a specific subperiod. The properties of expectations models based on the time series of earnings are contrasted with earnings expectations models based on security returns. The latter exhibit no evidence of systematic post-announcement drift behavior. The expectations models based on security returns have the appealing property that the assignment of firms to unexpected earnings change portfolios better approximates the independence-over-time assumption. This property means that these models are less vulnerable to the "proxy effect" criticism that has been made of results previously reported in the literature. The results in this paper are based on a sample of over 56,000 observations covering the 1974 to 1981 time period.

We hypothesize and find evidence consistent with foreign firms being tax-favored acquirers of U.S. targets with greater locked-out earnings because they can avoid the U.S. tax on repatriations. This effect is economically significant; a standard deviation increase in lockout is associated with a 12% relative increase in the likelihood that an acquirer is foreign. We also find evidence that foreign acquirers of the target firms are more likely to be residents of countries that use territorial tax systems, as the tax advantages for a foreign firm acquiring a U.S. target with locked-out earnings are even greater for these acquirers.