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Abstract:
This paper develops and analyzes two models of asset valuation from which the appropriate discounts for lack of marketability, blockage, and minority ownership are derived. The analysis of the model shows that a lack of prospective buyers is a necessary but not sufficient condition for a discount for lack of marketability. Heterogeneous beliefs among prospective buyers regarding the value of the asset are also required. A consequence of this result is that the proper marketability discount for an interest in a partnership that holds easily valued investment assets is zero. A discount for owning a minority interest reflects the ability of a majority owner to indirectly transfer wealth to himself at the expense of the minority owner. If a discount exists, it is decreasing in the cost of the transfer to the corporation and decreasing in the ownership interest of the majority shareholder.

Abstract:
Using a model of corporate investment in which the deferred tax liability never reverses, I show that deferred taxes are a real economic burden whose value is the amount recognized multiplied by a fraction. The numerator of the fraction is the tax depreciation rate, and the denominator of the fraction is the sum of the tax depreciation rate and the cost of capital. Intuitively, even though the deferred tax liability never reverses, the difference between tax and book depreciation decreases over time because the tax bases of the assets gradually diverge from their book value.

Abstract:
Using a model of corporate investment in which the deferred tax liability never reverses, I show that deferred taxes are a real economic burden whose value is the amount recognized multiplied by a fraction. The numerator of the fraction is the tax depreciation rate, and the denominator of the fraction is the sum of the tax depreciation rate and the cost of capital. Intuitively, even though the deferred tax liability never reverses, the difference between tax and book depreciation decreases over time because the tax bases of the assets gradually diverge from their book value.

Abstract:
Although both Canada and the United States use the ?arm?s length standard? when evaluating transfer prices for tax purposes, they disagree over which transfer pricing methods are acceptable. Both countries accept methods based on comparable transactions and gross margins of comparable products. The U.S. also accepts, and may in practice prefer, methods based on net profits of comparable firms. Canada resists using the comparable profit method. This paper examines the effects of the various transfer pricing methods on the allocation of taxable income in a model in which organization structure affects the level of relationship-specific investments made by vertically integrated groups and comparable independent firms. Analysis of the model shows that the five transfer pricing methods considered are not equivalent. The comparable profit method allocates less income to Canada in cases involving U.S. parents and Canadian subsidiaries, and in cases in which more reliable gross margin data is available for U.S. firms than for Canadian firms.

Abstract:
This paper compares two attributes of a deferred tax liability (DTL) that arise from differences in book and tax depreciation methods. The first attribute is the effect of the DTL on the market value of the firm. The second is the length of time between when the asset is placed into service and when the DTL associated with that asset begins to reverse. The paper shows that a decrease in the time it takes for the DTL to begin to reverse is neither necessary nor sufficient for the value of the DTL to increase. It also shows that the value of the DTL is not equal to the present value of the future deferred tax expense. The effect of one dollar of DTL on firm value depends only on the tax depreciation rate and the discount rate.

Deferred Income Taxes, Depreciation, Valuation

Abstract:
We examine the current accounting controversy over dividend tax capitalization using a model in which we model explicitly the investment and dividend policies of the firm. We measure dividend tax capitalization using Tobin's q. Our analysis shows that the effect of dividend taxes on Tobin's q depends on whether the firm is in a growth stage or a mature stage, as well as on whether earnings are distributed to shareholders via dividends, stock repurchase, or liquidation.

Tobin's q for a firm in the growth stage is increasing in the dividend tax rate, and q is greater than one. When dividend irrelevance occurs for mature firms, q becomes less than one. If earnings are distributed via stock repurchases instead of dividends, q exceeds one.

We also show that investor-level taxes can either increase or decrease the value of retained earnings relative to contributed capital, depending on the stage of the firm's life cycle and how earnings are distributed.

Dividend tax capitalization; Valuation; Tobin's q

Abstract:
This paper examines the properties of the effective tax rate (ETR) as a measure of managerial tax planning effectiveness using a principal-agent model. ETR is calculated as Tax Expense (computed pursuant to SFAS No. 109) divided by Income Before Taxes. The changes in ETR due to the agent's actions are systematically different from the changes in the principal's tax burden. These differences suggest that ETR is an ineffective measure of the agent's performance.

Performance evaluation, tax planning, effective tax rates, agency theory

Abstract:
We investigate the use of bilateral advance pricing agreements (BAPAs) to resolve transfer pricing disputes between a taxpayer and two tax authorities. BAPAs are designed to protect firms from double taxation while reducing expected compliance costs (audits costs plus BAPA implementation costs). We identify settings in which we expect BAPAs to arise and investigate the effect of the program on compliance costs. We show that a reduction in expected compliance costs is a necessary but not sufficient condition for an agreement to be reached. Agreements are more likely to arise when the amount of income potentially subject to double taxation is low and the difference in tax rates between the two countries is high. We also show that the existence of the BAPA program can increase tax compliance costs in settings in which the absence of a BAPA conveys information to the tax authorities, inducing them to audit a taxpayer without a BAPA more intensively than they would have had the BAPA program not existed. Although this outcome is socially inefficient, it increases the expected net payoff (taxes collected less tax compliance costs) of the country with the higher tax rate.

Bilateral advance pricing agreements, transfer pricing, tax compliance, game theory

Abstract:
We develop a model to examine the effects of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on the strategic interaction between publicly-traded corporate taxpayers and the government. Some of our findings contradict conjectures voiced by members of the business community regarding the economic effects of implementing FIN 48. Specifically, taxpayers with strong facts obtain higher expected payoffs from uncertain tax benefits and some disclosed liabilities understate the expected tax liability. Consistent with the common conjectures, however, some taxpayers are more likely to be audited or are deterred from entering into transactions that generate uncertain benefits because of FIN 48.

tax compliance, FIN 48, ASC 740-10-25, accounting for income taxes, disclosure

Abstract:
We examine a firm's corporate governance choices within a competitive environment. A firm can choose a passive board that delegates decision rights to the executive manager, or an active board that retains these rights. We characterize the equilibrium governance choices and find that there generally is no systematic relation between governance systems and firm performance. We discuss how the governance choice is affected by the rate of technological innovation, board expertise, the discount rate, the benefit of using new technology, and the cost of operating an internal control system. Finally, we analyze consequences of the Sarbanes-Oxley Act.

Corporate governance, board of directors, internal controls, competition

Abstract:
This paper develops a model of corporate investment in which a certain fraction of the investment is immediately expensed. This model is representative of the treatment of costs associated with internally developed intangible assets, which generally are expensed for both financial reporting and tax purposes. Analysis of the model shows that accounting-based measures of tax preferences are deficient because such measures only detect tax preferences that generate book-tax differences. The paper then proposes a new measure based on stock market returns, which detects tax-favored investments regardless of the financial accounting treatment of the investment. The accounting-based and market-based measures are estimated using data from the 1988-1996 period. Although the accounting-based measure suggests that corporate investments are slightly tax disfavored, the market-based measure suggests that investments in the corporate sector are substantially tax-favored, bearing an explicit tax rate of about 20 percent.

Abstract:
This paper examines the effect of accounting on the use of intellectual property. We analyze the licensing of intellectual property in exchange for royalties that depend on the self-report of the licensee. The self-reporting aspect of the environment gives rise to demand for auditing by the licensor or third-party attestation by the licensee. We characterize the optimal royalty contract, accounting system choice by the licensee, and audit strategy choice by the licensor. We show when the owner prefers to license the property in exchange for a royalty and when it prefers to use the property directly. We find that variable royalty arrangements that depend on either audited self-reports or third-party attestation become more attractive as accounting information system costs decrease and as the benefits from outsourcing the use of intellectual property increases. We also examine how different licensing arrangements affect the relation between the variance of the returns to the intellectual property and the payoff to the owner.

Royalties, licensing, strategic auditing, contract compliance, forensic accounting

Abstract:
This paper uses a strategic tax compliance model to examine taxpayer reporting and tax authority audit strategies in an international setting with two tax authorities. The setting features both information asymmetry between the taxpayer and the tax authorities and tax law ambiguity. The latter creates the possibility of each country trying to tax the same income. We study the effect of the probability of tax law ambiguity on the strategies and payoffs of the taxpayer and the tax authorities. The analysis of the model yields three surprising insights. First, an increase in tax law ambiguity can decrease the taxpayer's expected tax liability. Second, an increase in tax law ambiguity can decrease expected government revenues, net of audit costs. Third, an increase in tax law ambiguity can increase social welfare by decreasing the deadweight loss associated with tax compliance.

Tax compliance, multinational taxation, double taxation

Abstract:
This paper develops a model of a firm's foreign investment decisions and characterizes its optimal investment and repatriation strategies. It then derives the theoretical relation between the level of a foreign subsidiary's permanently reinvested earnings as reported in the income tax footnote and the value of the subsidiary to the parent. It shows that the valuation relevance of this item depends on whether the earnings are invested in operating assets or financial assets. It also shows the effects of a temporary tax holiday on firm value.

Taxation, multinational investment, permanently reinvested earnings, tax holidays

Abstract:
This paper develops a model of a firm's foreign investment decisions and characterizes its optimal investment and repatriation strategies. It then derives the theoretical relation between firm value and the book value of the deferred tax liability associated with such investments or, if no liability is recognized for financial reporting purposes, the reduction in firm value associated with permanently reinvested foreign earnings. It shows that the valuation relevance of these items depends on whether the earnings are invested in operating assets or financial assets. It also shows the effects of a temporary tax holiday on firm value.

Taxation, multinational investment, deferred tax liability, permanently reinvested earnings

Abstract:
This paper develops a model of dynamic tax planning in which the implementation of a tax plan involves exercising the option regarding an irreversible investment or financing structure choice. The model is applied to a common estate freeze tax plan. Undertaking an estate freeze requires a private company's owner-manager to choose how one's business assets are to be distributed at death. In contrast to the conventional wisdom regarding the timing of this strategy, we find that waiting to implement the strategy is often optimal. We test the model using data on family-owned businesses in Canada and find strong support for the model's predictions.

Tax planning, estate freezes, real options, family-owned businesses

Abstract:
The non-profit sector in the United States owns investment assets of about $1 trillion. Nearly half of these assets are owned by private foundations. The tax law requires that private foundations spend at least five percent of their assets each year on charitable purposes. Despite this minimum distribution requirement, private foundations doubled in size between 1994 and 1998. This paper examines the distributions made by a sample of private foundations between 1994 and 1998 using actual tax return data. It examines the amount and timeliness of these distributions. It also examines the level of administrative expenses per dollar of grants. It finds substantial variation among foundations with respect to each measure. It also finds that the tendency for a foundation to minimize the amounts currently transferred to charitable beneficiaries is positively correlated with size, fraction of operating expenses paid to outside experts, fraction of operating expenses paid to foundation officers, directors, and trustees, and is negatively associated with the fraction of current revenues from new contributions.

Private Foundations, Non-profit Organizations, Payout, Minimum Distribution Requirement

Abstract:
We investigate the effect of shareholder taxes on expected stock returns using a model that characterizes both the optimal portfolios of taxable and tax-exempt investors and the expected rates of return on risky stocks. When all income is taxed at the same effective rate, each investor's ownership in each risky stock depends only on that investor's relative tolerance for risk. Taxes induce taxable investors to hold more of the tax-favored stock, but risk-sharing considerations induce each investor to hold some stock unless the riskiness of the stock is sufficiently low. There is no "marginal investor" in this case. Each stock's expected return reflects a "dividend tax penalty," but the dividend tax penalty is not mitigated by the fraction of shares held by the tax-exempt investors. Although the presence of the tax-exempt investors in the market does mitigate the dividend penalty for the market as a whole, this effect is identical for all firms held by both taxable and tax-exempt investors and does not vary with the fraction of shares held by the tax-exempt investors.

Dividend tax capitalization, tax clienteles, tax-exempt investors, implicit taxes

Abstract:
We characterize the effects of different methods of taxing multinational income on productive efficiency in a competitive equilibrium. The efficient outcome is achieved when every firm that produces and sells domestically faces the same tax rate as a multinational firm selling into the same country. This can occur under either separate accounting or formulary apportionment. A shift from separate accounting to formulary apportionment increases productive efficiency when the weight on the sales factor is sufficiently high and decreases productive efficiency when the weight on the sales factor is sufficiently low. Equal tax rates between countries is not necessary for the efficient outcome to be achieved under either separate accounting or formulary apportionment.

Formulary apportionment, separate accounting, transfer pricing

Abstract:
This paper examines the effects of banning contingent fees for tax return preparation services. It develops a principal-agent model in which a taxpayer contracts with a tax practitioner to attempt to resolve tax law uncertainty. The contract must induce the practitioner to do research and take the tax return reporting position that the taxpayer prefers. Analysis of the model shows that banning contingent fees raises the expected fee of the practitioner. The amount of the increase is increasing in the quality of the practitioner. Contrary to the conventional wisdom that holds that contingent fee arrangements will make practitioners more likely to take aggressive tax return positions, we find that practitioners are less likely to be aggressive when contingent fees are allowed.

Abstract:
This paper examines the effects of banning contingent fees for tax return preparation services. It develops a principal-agent model in which a taxpayer contracts with a tax practitioner to attempt to resolve tax law uncertainty. The contract must induce the practitioner to do research and take the tax return reporting position that the taxpayer prefers. Analysis of the model shows that banning contingent fees raises the expected fee of the practitioner. The amount of the increase is increasing in the quality of the practitioner. Contrary to the conventional wisdom that holds that contingent fee arrangements will make practitioners more likely to take aggressive tax return positions, we find that practitioners are less likely to be aggressive when contingent fees are allowed.

Abstract:
This paper develops and analyzes a model in which tax considerations and financial reporting considerations have countervailing effects on a firm's investments in internally developed intangible assets. It also proposes and estimates a new measure of tax preferences, which we call the economic effective tax rate. This measure reflects both investments in intangible assets and the use of debt financing, neither of which generates a book-tax difference. Our measure indicates that the economic effective tax rate was about 18 percent between 1988 and 2005, when the statutory tax rate was either 34 or 35 percent.

intangible assets, tax preferences, effective tax rates, financial reporting costs

Abstract:
This paper develops and analyzes a model in which tax considerations and financial reporting considerations have countervailing effects on a firm's investments in internally developed intangible assets. It also proposes and estimates a new measure of tax preferences, which we call the economic effective tax rate. This measure reflects both investments in intangible assets and the use of debt financing, neither of which generates a book-tax difference. Our measure indicates that the economic effective tax rate was about 18 percent between 1988 and 2005, when the statutory tax rate was either 34 or 35 percent.

Intangible assets, tax preferences, effective tax rates, financial reporting costs

Abstract:
This paper uses a strategic tax compliance model to examine taxpayer reporting and tax authority audit strategies in an international setting with two tax authorities. The setting features both information asymmetry between the taxpayer and the tax authorities and inconsistent tax transfer pricing rules. The latter creates the possibility of each country trying to tax the same income. We study the effect of the probability of transfer price rule inconsistency on the strategies and payoffs of the taxpayer and the tax authorities. We find that an increase in the probability of transfer price rule inconsistency induces more aggressive auditing by governments. It therefore deters taxpayers from shifting income to the low-tax rate country in situations in which the transfer pricing rules are consistent, and can either increase or decrease the income reported to the low-tax country in cases in which the transfer price rules are inconsistent. We find that an increase in transfer price rule inconsistency could either increase or decrease the taxpayer's expected tax liability and could either increase or decrease the deadweight loss from auditing. Our results call into question the conventional wisdom that the prospect of double taxation due to transfer price rule inconsistency increases a firm's expected tax liability and governments' expected audit costs.

Tax compliance, transfer pricing, double taxation, tax law inconsistency

Abstract:
This paper examines the consequences of allowing a non-profit organization to form a joint venture with a for-profit organization. Three tax regimes are considered: prohibiting all such joint ventures; allowing all such joint ventures; and restricting joint ventures between non-profit and for-profit entities to those controlled by the non-profit organization. The paper derives the equilibrium profit sharing rule, output decision, and organizational form choice under each tax regime. Joint ventures can create both private and social benefits by reducing production costs. They can also create private benefits and social costs by reducing competition. Prohibitions or restrictions on joint ventures can either increase or decrease social welfare depending on whether the production cost effect or the competition effect is more important.

Abstract:
Profits a tax-exempt organization earns from business activities that are not related to the organization's exempt purpose are subject to the unrelated business income tax (UBIT). This paper shows that when the taxable and tax-exempt activities are substitutes, taxable income exceeds the incremental pretax financial return from the unrelated business activity because the exempt organization cannot deduct the opportunity cost of lost exempt function revenues when computing UBIT. As a result, the exempt organization may: (1) reduce or eliminate its unrelated business activity, or (2) change the way it uses its assets for unrelated business purposes by licensing the use of its assets to an unrelated taxable organization in exchange for nontaxable royalties. The model shows that although UBIT may distort the way in which an exempt organization uses its assets, this distortion can increase social welfare.

Unrelated business income tax, exempt organizations, income measurement

Abstract:
We propose an explanation for why states choose different apportionment formulas for corporate income tax purposes. Based on a two-state equilibrium model of location choice by firms, we show that aggregate social welfare is maximized when both states use the same formula, regardless of which formula is chosen. However, at least one of the states can increase its welfare by deviating from this coordinated solution; thus, the Nash equilibrium features the states choosing different formulas. Importing states have incentives to increase the sales factor, whereas exporting states will tend to increase the input factors. An empirical test of which states have deviated from the traditionally equally-weighted three factor formula supports the predictions of the model.

Abstract:
The revised Treasury Regulations interpreting Internal Revenue Code Section 482 allow the use of profit-based transfer pricing methods, as well as the older methods based on prices from comparable transactions between independent parties. This paper compares the effects of price-based and profit-based transfer pricing methods on the allocation of taxable income in a model in which organization structure affects the level of relationship-specific investments made by vertically integrated groups and comparable independent firms. Analysis of the model shows that the price-based methods systematically allocated more taxable income to foreign subsidiaries and less to domestic parents than does the profit-based method.

Abstract:
This paper develops, analyzes, and tests a strategic tax compliance model in which the taxpayer reports both financial accounting income and taxable income. The government observes both reports before deciding whether to conduct an audit. Our theoretical analysis of the taxpayer's joint financial and tax reporting decision generates two hypotheses. First, the probability that the government will audit a transaction is higher if the transaction generates a positive book-tax difference (e.g., an expenditure that is deducted for tax purposes but capitalized for financial reporting purposes) than if the transaction generates no book-tax difference. Second, conditional on being selected for audit, transactions with and without book-tax differences are equally likely to have detected understatements of tax liability. These hypotheses are tested using IRS data from the Coordinated Examination Program. The empirical tests are consistent with the predictions of the strategic tax compliance model.

Abstract:
The new Treasury Regulations interpreting Section 482 allow the use of profit-based transfer pricing methods, as well as the older methods based on market prices and gross margins. This paper examines the effects of the Regulations in a model in which organization structure affects the level of relationship specific investments. Analysis of the model suggests new methods allowed in the Regulations will help the IRS litigate transfer pricing cases involving U.S. parents and foreign subsidiaries, and will allocate income in a manner commensurate with the economic value added to a greater degree than did the earlier methods.

Abstract:
This paper examines two financial accounting measures of corporate income tax liabilities: the deferred tax liability and the average effective tax rate. It derives the appropriate way to discount the deferred tax liability for valuation purposes. It also shows that effective tax rates based on financial accounting data fail to detect tax- favored investments that do not generate temporary differences. A new measure based on stock market returns detects tax-favored investments, regardless of whether they generate book-tax differences. However, the market based measure contains a source of measurement error not found in accounting based measures