Financial Statement Tax Disclosures and Corporate Innovation
46 Pages Posted: 17 May 2018 Last revised: 10 Jul 2019
Date Written: July 8, 2019
In this paper, we analyze the real effect of financial statement tax disclosures on corporate innovation activities. In 2007, the FASB issued FIN 48, which mandates the separate disclosure of reserves for unrecognized tax benefits (UTBs). Tax credits for innovation comprise a significant portion of this reserve because of their higher likelihood of being disallowed by the IRS upon audit. Given that UTB disclosure increases IRS scrutiny and, in consequence, decrease the likelihood of receiving tax credits, we expect net present values of innovation to decrease. Using patent applications as a measure of corporate innovation, we employ a difference-in-difference research design with publicly listed U.S. firms as the treatment group and privately held U.S. firms as the control group. We hypothesize and find robust evidence that following the onset of FIN 48, the number of patent applications by publicly listed firms decreased. We also provide evidence that the decrease is attributable to incremental innovation, which is more subject to the UTB disclosure requirements, and we provide evidence that our findings are more concentrated amongst firms less likely to be audited by the IRS prior to FIN 48. Overall, our evidence provides support for the real effects of disclosures on innovation activities.
Keywords: Uncertain tax positions, FIN 48, Radical Innovation, Incremental Innovation, Patents, Backward Citations
JEL Classification: M40, M41, M48, O30, O38
Suggested Citation: Suggested Citation