Tightening the Noose: The Impact of FIN 48 on Corporate Borrowers

Posted: 13 Feb 2013

See all articles by Raquel Meyer Alexander

Raquel Meyer Alexander

Washington and Lee University

Andrew D. Gross

University of Wisconsin - Milwaukee - Sheldon B. Lubar School of Business

Vernon J. Richardson

University of Arkansas at Fayetteville

George Ryan Huston

Arizona State University (ASU) - School of Accountancy

Date Written: February 6, 2013

Abstract

We investigate the interaction of debt covenants and tax reporting upon the adoption of a financial accounting standard that codifies disclosures for income tax risks, Financial Interpretation No. 48 (FIN 48). We examine how firms respond to the potential tightening of covenant slack upon FIN 48 adoption and whether these actions are penalized by creditors and anticipated by equity market. While FIN 48 generally results in firms reducing equity, we find that firms close to net worth covenants are more likely to reduce equity, but tend to make smaller (less negative) adjustments, consistent with prior research that shows firms try to avoid costly covenant violations. For firms near net worth debt covenant violation, the act of decreasing equity upon FIN 48 adoption leads to an average increase in cost of debt of 43 basis points. Our results suggest that the market anticipated potential debt impacts associated with FIN 48 as the cumulative abnormal return at the FIN 48 exposure draft release date is negative only for firms with large book-tax differences (more tax aggressive firms) that are also close to debt covenant violation.

Suggested Citation

Alexander, Raquel Meyer and Gross, Andrew D. and Richardson, Vernon J. and Huston, George Ryan, Tightening the Noose: The Impact of FIN 48 on Corporate Borrowers (February 6, 2013). 2013 American Taxation Association Midyear Meeting: Uncertain Tax Positions. Available at SSRN: https://ssrn.com/abstract=2216917

Raquel Meyer Alexander (Contact Author)

Washington and Lee University ( email )

204 W Washington St
Lexington, VA 24450
United States

Andrew D. Gross

University of Wisconsin - Milwaukee - Sheldon B. Lubar School of Business ( email )

P.O. Box 742
3202 N. Maryland Ave.
Milwaukee, WI 53201-0742
United States

Vernon J. Richardson

University of Arkansas at Fayetteville ( email )

401 WCOB
Fayetteville, AR 72701
United States

George Ryan Huston

Arizona State University (ASU) - School of Accountancy ( email )

Tempe, AZ 85287
United States

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