Evidence of Non-Compliance and Strategic Behavior on Tax Rates Applied to Non-GAAP Exclusion Items

58 Pages Posted: 6 Aug 2019

See all articles by Novia (Xi) Chen

Novia (Xi) Chen

University of Houston - Department of Accountancy & Taxation

Peng-Chia Chiu

The Chinese University of Hong Kong, Shenzhen

Terry J. Shevlin

University of California-Irvine

Jiani Wang

University of International Business and Economics (UIBE)

Date Written: July 29, 2019

Abstract

When reporting after-tax non-GAAP earnings, firms need to adjust for the tax effects of non-GAAP exclusions. Since 2010, the SEC has issued two Compliance and Disclosure Interpretations (hereafter, C&DIs) which specifically mandate the tax effects of exclusions to be separately disclosed. In this study, we assemble a detailed hand-collected dataset of S&P 1500 firms to provide the first large-sample evidence on the reporting of the tax effects. We document three findings. First, echoing the SEC’s concern, a significant proportion of non-GAAP reporting firms do not comply with the C&DIs’ disclosure requirements (i.e., the tax effects of exclusions are not separately disclosed). Second, among firms that comply with the C&DIs and disclose the tax effects of exclusions, we find that managers opportunistically use the tax rate applied to non-GAAP exclusions (hereafter, TREx) to achieve after-tax earnings targets. Third, firm-reported non-GAAP earnings calculated using TREx are less persistent for future operating earnings and cash flows, as compared to non-GAAP earnings calculated using various benchmark tax rates. Overall, our study provides the first large-sample evidence on firms’ strategic use and reporting of TREx.

Keywords: Income taxes, Non-GAAP Reporting

Suggested Citation

Chen, Novia (Xi) and Chiu, Peng-Chia and Shevlin, Terry J. and Wang, Jiani, Evidence of Non-Compliance and Strategic Behavior on Tax Rates Applied to Non-GAAP Exclusion Items (July 29, 2019). Available at SSRN: https://ssrn.com/abstract=3430796 or http://dx.doi.org/10.2139/ssrn.3430796

Novia (Xi) Chen (Contact Author)

University of Houston - Department of Accountancy & Taxation ( email )

Bauer College of Business
4800 Calhoun Road
Houston, TX 77204
United States

Peng-Chia Chiu

The Chinese University of Hong Kong, Shenzhen ( email )

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

Jiani Wang

University of International Business and Economics (UIBE) ( email )

10, Huixin Dongjie
Changyang District
Beijing, Beijing 100029
China

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