Does Mandatory Disclosure Affect Recognition of Contingent Liabilities? Evidence from FIN 48
43 Pages Posted: 5 Aug 2011 Last revised: 29 Aug 2011
Date Written: August 1, 2011
This paper investigates whether mandatory disclosure affects managers’ decisions to recognize contingent tax liabilities. Because of the proprietary nature of tax disclosures, some managers have an incentive to minimize tax reserves and to limit the quality of disclosures, while others prefer to maintain large tax reserves to meet future earnings goals. If large tax reserves are maintained, additional disclosure may be beneficial to reduce information asymmetry between managers and financial statement users. I find that firms that increase tax reserves when they implement FIN 48 are more likely to issue higher quality FIN 48 disclosures. Poor disclosure quality is associated with higher future tax expense and lower future cash taxes, suggesting that these firms are benefiting from under-accruing tax reserves and disclosing less about their contingent tax liabilities.
Keywords: Contingent liabilities, FIN 48, mandatory disclosure, voluntary disclosure, proprietary cost, tax reserves, voluntary disclosure
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