Taxes, conservatism in financial reporting, and the value relevance of accounting data

Abstract

This study investigates whether taxes affect conservatism in financial reporting and the relevance of the resulting financial accounting data for valuation purposes. My motivation is to provide evidence on taxation as a determinant of financial reporting conservatism in the United States. I predict and find that firm years with large positive (negative) differences between pre-conservative financial reporting and taxable income are the most (potentially least) conservative and that they are less (more) conservative after taxes change. This evidence is consistent with taxes being a determinant of conservatism. In addition, I examine whether the value relevance of financial accounting information to investors is impaired for firm years that are influenced by taxation. The evidence in my value relevance tests is generally consistent with the value relevance in financial reporting information not necessarily being impaired when tax rules influence financial reporting incentives.