Real Effects of Financial Reporting on Innovation: Evidence from Tax Law and Accounting Standards

The Accounting Review, Forthcoming https://doi.org/10.2308/TAR-2018-0582

60 Pages Posted: 6 Feb 2020 Last revised: 8 Feb 2021

See all articles by Braden Williams

Braden Williams

University of Texas at Austin - Department of Accounting

Brian Williams

Indiana University - Kelley School of Business - Department of Accounting

Date Written: October 15, 2020

Abstract

This study examines whether financial accounting standards moderate the effectiveness of tax policy. Specifically, we examine whether myopic managers’ focus on short-term financial reporting reduces the effectiveness of tax subsidies that incentivize innovation. We employ a novel setting, the issuance of Financial Interpretation No. 48 (FIN 48), which changed the financial reporting for some important, yet uncertain, tax incentives to innovate. For firms most affected by the standard change, we find evidence of reduced investment in innovation, reduced sensitivity of investment to tax incentives, and reduced future innovative output. Consistent with earnings myopia, we find the effect is more pronounced in firms with higher levels of transient institutional ownership and newly vesting equity compensation. These results indicate financial reporting myopia has real effects on innovation and can reduce tax policy effectiveness. The results further suggest that tax policymakers should consider both financial reporting and cash flow incentives in designing policy.

Keywords: Innovation, Accounting Recognition, FIN 48

JEL Classification: H25, M41

Suggested Citation

Williams, Braden and Williams, Brian, Real Effects of Financial Reporting on Innovation: Evidence from Tax Law and Accounting Standards (October 15, 2020). The Accounting Review, Forthcoming https://doi.org/10.2308/TAR-2018-0582 , Available at SSRN: https://ssrn.com/abstract=3519300 or http://dx.doi.org/10.2139/ssrn.3519300

Braden Williams (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States

Brian Williams

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

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