Voluntary explanations of effective tax rate decreases
McGuire, Sean Thomas
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This study investigates the determinants and content of voluntary explanations that firms provide for a fourth quarter decrease in their effective tax rate (ETR). Recent evidence suggests market participants do not fully understand the implications of earnings created by a decrease in ETR. Economic theory predicts firms will provide supplemental information to help market participants interpret the implications of earnings components for firm value. However, theory also asserts that the decision to disclose additional information will vary with the costs of disclosure. ETR decreases provide an interesting setting to investigate firms’ disclosure choices because a decrease in ETR is potentially the result of two activities that have a high cost of disclosure: earnings management and tax planning. Using a hand-collected sample of earnings announcements, I find that approximately 10 percent of the firms with a fourth quarter ETR decrease explain the decrease. Results suggest firms with larger ETR-related earnings are more likely to explain an ETR decrease, while firms that opportunistically manage their ETR and firms that engage in significant tax planning are less likely to provide an ETR-related explanation. These results are consistent with firms disclosing less information in settings where the costs of reducing the information asymmetry between the firm and investors (e.g., when managing earnings) or regulators (e.g., when engaging in tax planning) are particularly high. I also analyze the content of ETR-related explanations and find firms with an ETR decrease are more likely to indicate the ETR change is permanent. Collectively, my results suggest that firms strategically explain ETR decreases and use disclosure in an attempt to enhance market participants’ perception of earnings created by an ETR decrease.