Do Smoothing Activities Indicate Higher or Lower Financial Reporting Quality? Evidence from Effective Tax Rates

55 Pages Posted: 3 Apr 2016 Last revised: 17 Apr 2019

See all articles by Paul Demere

Paul Demere

University of Georgia - J.M. Tull School of Accounting

Laura Yue Li

University of Illinois at Urbana-Champaign

Petro Lisowsky

Boston University Questrom School of Business; Norwegian Center for Taxation

R. William Snyder

George Mason University

Date Written: April 15, 2019

Abstract

Prior literature is mixed as to whether smoothing through accruals indicates higher or lower financial reporting quality (Tucker and Zarowin 2006; Jayaraman 2008; Dechow et al. 2010). Motivated by the unique inter-temporal features and reporting incentives of tax expense, we provide new evidence on this debate by examining the link between smoothing of GAAP effective tax rates (ETRs) and the likelihood of financial restatements. Different from earnings smoothing’s insignificant relation with restatements, we find that ETR smoothing through tax accruals is strongly associated with a lower likelihood of financial restatement and tax-related financial reporting fraud. Further investigation reveals that these associations are stronger in firms with a higher level of discretion in tax reporting and when the demand for transparent reporting is higher. We also document corroborating evidence that smoothing through tax accruals increases the informativeness of GAAP ETRs for predicting future cash ETRs. Collectively, our results contribute to the financial reporting and tax literatures by providing evidence that smoothing activities pertaining to tax accruals are consistent with higher financial reporting quality.

Keywords: effective tax rates, financial reporting quality, smoothing, managerial discretion

JEL Classification: M41, M48, H26

Suggested Citation

Demere, Paul and Li, Yue Laura and Lisowsky, Petro and Snyder, R. William, Do Smoothing Activities Indicate Higher or Lower Financial Reporting Quality? Evidence from Effective Tax Rates (April 15, 2019). Available at SSRN: https://ssrn.com/abstract=2757786 or http://dx.doi.org/10.2139/ssrn.2757786

Paul Demere

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

Yue Laura Li

University of Illinois at Urbana-Champaign ( email )

283 Wohlers hall 1206 South Sixth Street
1206 South Sixth Street
Champaign, IL 61820
United States
2172655086 (Phone)

Petro Lisowsky (Contact Author)

Boston University Questrom School of Business ( email )

595 Commonwealth Avenue
Ste. 518H
Boston, MA 02215
United States
6173532661 (Phone)

Norwegian Center for Taxation ( email )

Helleveien 30
Bergen, Bergen 5045
Norway

R. William Snyder

George Mason University ( email )

Fairfax, VA
United States

HOME PAGE: http://business.gmu.edu/facultyandresearch/faculty/accounting/profile/47/145/

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