The Importance of IRS Enforcement to Stock Price Crash Risk: The Role of CEO Power and Incentives

The Accounting Review, forthcoming

67 Pages Posted: 5 Jun 2017 Last revised: 24 Jul 2020

See all articles by Andrew M. Bauer

Andrew M. Bauer

University of Waterloo - School of Accounting and Finance

Xiaohua Fang

Florida Atlantic University

Jeffrey Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Date Written: March 3, 2020

Abstract

We analyze whether tough IRS monitoring generates a positive externality by constraining managers’ bad news hoarding activities. Supporting this prediction, we find a negative relation between the threat of an IRS audit and stock price crash risk. Our evidence is consistent with recent theory that outside investors learn more about firms when tax enforcement is stricter. Additionally, path analysis suggests that the monitoring channel (direct path) plays a critical role in shaping crash risk relative to information asymmetry channels of tax planning and accruals manipulation (indirect paths). Consistent with other predictions, we find that the monitoring role of IRS audits intensifies when firms experience worse agency conflicts stemming from CEO power and incentives. Collectively, our research implies that external monitoring by tax authorities protects shareholders against managers suppressing negative firm-specific information that engenders stock price crash risk, particularly when CEOs have wider scope and stronger incentives to hoard bad news.

Keywords: tax enforcement; monitoring; stock price crash risk; information asymmetry; managerial agency conflicts

Suggested Citation

Bauer, Andrew M. and Fang, Xiaohua and Pittman, Jeffrey A., The Importance of IRS Enforcement to Stock Price Crash Risk: The Role of CEO Power and Incentives (March 3, 2020). The Accounting Review, forthcoming, Available at SSRN: https://ssrn.com/abstract=2980012 or http://dx.doi.org/10.2139/ssrn.2980012

Andrew M. Bauer

University of Waterloo - School of Accounting and Finance ( email )

200 University Ave W
Waterloo, Ontario N2L 3G1
Canada

Xiaohua Fang

Florida Atlantic University ( email )

United States

Jeffrey A. Pittman (Contact Author)

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

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