Corporate Tax Reserves, Firm Value, and Leverage

Abstract

New accounting rule FIN 48 compels public corporations to disclose how much money they have reserved for financial reporting purposes in order to pay the U.S. and foreign governments in the event that tax-saving transactions are successfully challenged by the IRS and other taxing authorities. Tests using a sample of 273 industrial firms whose 2007:I 10-Q filings adhered to the new reporting requirement indicate that the amount of reserves is a significantly positive determinant of firm value regardless of endogeneity control. Profitable high-reserve firms both reduced their reserve levels and significantly increased their leverage from 2005 to 2007, suggesting tax-sheltering activities being displaced by more debt utilization prior to the mandatory FIN 48 reporting. This result complements Graham and Tucker (2006) who report that tax sheltering appears to be a significant determinant of corporate debt utilization.

Keywords: FIN 48, taxes, tax reserves, tax shelters, firm value, leverage

JEL Classification: G12, G32, K34, M41, M44