Financial Statement Comparability and Corporate Tax Strategy

Abstract

We investigate whether a firm’s financial statement comparability is associated with the firm’s tax strategy. We hypothesize that external observers (e.g., press, shareholders, analysts, and tax authorities) can better detect a firm’s atypical tax strategy when the firm has high financial statement comparability with its industry peers. Detection and its consequent penalties should restrain firm managers from choosing tax strategies that deviate significantly from those of industry peers. Using firms’ uncertain tax benefits (UTBs) as a proxy for tax avoidance, we find that the UTBs of firms with high financial statement comparability move toward their industry peers in subsequent periods. Results suggest that comparability reduces tax aggressiveness for high tax-avoidance firms and enhances tax aggressiveness for low tax-avoidance firms, in comparison with those of industry peers. Overall, these findings indicate a strong within-industry harmonization in tax avoidance for firms with high financial statement comparability.

Keywords: Financial statement comparability, Tax distance, Tax aggressiveness, Undersheltering, IRS detection, Manager’s incentives

JEL Classification: H26, M41, M48