Do smoothing activities indicate higher or lower financial reporting quality? Evidence from effective tax rates
Li, Laura Yue
Snyder, R. William
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Citation (published version)Paul Demere, Laura Yue Li, Petro Lisowsky, R William Snyder. "Do Smoothing Activities Indicate Higher or Lower Financial Reporting Quality? Evidence from Effective Tax Rates."
Prior literature is mixed as to whether smoothing through accruals indicates higher or lower financial reporting quality. Motivated by the unique features and incentives of tax expense, we provide new evidence by examining the link between smoothing of GAAP effective tax rates (ETRs) and financial restatement likelihoods. Different from earnings smoothing’s insignificant relation with restatements, we find that ETR smoothing through tax accruals is associated with a lower likelihood of financial restatement and tax-related financial reporting fraud. Further investigation reveals that these associations are stronger in firms with a higher level of discretion in tax reporting and when the demand for transparent reporting is higher. We also document that smoothing through tax accruals increases the informativeness of GAAP ETRs for predicting future cash ETRs. Collectively, our results contribute to the accounting literature by providing evidence that smoothing activities pertaining to tax accruals are consistent with higher financial reporting quality.
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