The Effect of Tax-Related Material Weaknesses in Internal Controls on the Market Valuation of Unrecognized Tax Benefits

46 Pages Posted: 31 Jan 2014 Last revised: 18 Sep 2014

See all articles by Allison Koester

Allison Koester

Georgetown University

Steve C. Lim

Texas Christian University - M.J. Neeley School of Business

Robert Vigeland

Texas Christian University

Date Written: September 11, 2014

Abstract

This paper examines the effect of tax-related material weakness in internal controls on investors’ valuation of unrecognized tax benefits (UTBs). Firms are required to record a UTB when their uncertain tax positions are unlikely to be sustained upon tax return audit. While Koester (2012) finds that investors positively value UTBs, we posit that a tax-related material weakness in internal controls over financial reporting (MWIC) represents information risk in the tax account, reducing the value-relevance of UTBs. We predict that the positive relation between market value of equity and UTBs is attenuated when firms report a tax-related MWIC, and our empirical tests reveal that the relation is completely mitigated in the presence of a tax-related MWIC. Falsification tests confirm that non-tax related MWICs do not attenuate the positive relation between market value of equity and UTBs, consistent with tax-related MWICs capturing low information quality specific to the tax account.

Suggested Citation

Koester, Allison and Lim, Steve and Vigeland, Robert, The Effect of Tax-Related Material Weaknesses in Internal Controls on the Market Valuation of Unrecognized Tax Benefits (September 11, 2014). Journal of American Taxation Association, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2386364 or http://dx.doi.org/10.2139/ssrn.2386364

Allison Koester

Georgetown University ( email )

McDonough School of Business
Washington, DC 20057
United States
202.687.6461 (Phone)

HOME PAGE: http://explore.georgetown.edu/people/apk29/

Steve Lim (Contact Author)

Texas Christian University - M.J. Neeley School of Business ( email )

2900 Lubbock Street
Fort Worth, TX 76129
United States
817-257-7536 (Phone)

Robert Vigeland

Texas Christian University ( email )

Fort Worth, TX 76129
United States

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