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The Effect of Tax Authority Monitoring and Enforcement on Financial Reporting Quality


Michelle Hanlon


Massachusetts Institute of Technology (MIT) - Sloan School of Management

Jeffrey L. Hoopes


Ohio State University (OSU) - Department of Accounting & Management Information Systems

Nemit Shroff


Massachusetts Institute of Technology (MIT) - Sloan School of Management

September 26, 2012

MIT Sloan Research Paper No. 4849-10

Abstract:     
In this paper, we examine the relation between tax enforcement and financial reporting quality. The government, thanks to its tax claim on firm profits, is de facto the largest minority shareholder in almost all corporations. Therefore, the government, like other shareholders, has an interest in the accurate reporting of (taxable) income and preventing insiders from siphoning corporate funds to obtain private benefits. We hypothesize and find evidence that higher tax enforcement and monitoring by the tax authority has a positive spillover effect on financial reporting by improving reporting quality. Further, we find that this effect is generally stronger when other monitoring mechanisms are weaker. We interpret our evidence as being consistent with the predictions from the Desai, Dyck, and Zingales (2007) theory that the tax authority provides a monitoring mechanism of corporate insiders. Our paper also adds to the literature on the determinants of financial reporting quality and how the relation between accounting standards and reporting outcomes depends on country level institutions.

Number of Pages in PDF File: 51

Keywords: Enforcement, Financial Reporting Quality, Earning Quality, IRS Audit

JEL Classification: G3, H25, H26, K34, M40

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Date posted: October 14, 2010 ; Last revised: October 13, 2012

Suggested Citation

Hanlon, Michelle and Hoopes, Jeffrey L. and Shroff, Nemit, The Effect of Tax Authority Monitoring and Enforcement on Financial Reporting Quality (September 26, 2012). MIT Sloan Research Paper No. 4849-10. Available at SSRN: http://ssrn.com/abstract=1691158 or http://dx.doi.org/10.2139/ssrn.1691158

Contact Information

Michelle Hanlon (Contact Author)
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States
617-253-9849 (Phone)
Jeffrey L. Hoopes
Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )
2100 Neil Avenue
Columbus, OH 43210
United States
Nemit Shroff
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States
6173240805 (Phone)
HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=51407&co_list=F
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