Financial Reporting-Influenced Tax Policy

• In Event: Debits, Credits, and Taxes

Abstract

This study examines the implications of enacting tax laws that are influenced by financial reporting considerations. We use states’ staggered adoption of deferred tax relief deductions (DTRDs) as our setting. DTRDs provide a tax credit to offset the revaluation of net deferred tax liabilities stemming from a state’s adoption of combined reporting. DTRDs provide a current financial reporting benefit to publicly traded companies, with actual cash tax savings delayed well into the future. We provide evidence that companies are less likely to relocate their headquarters out of states that adopt a DTRD law, suggesting that DTRDs can serve as a commitment mechanism, encouraging companies to maintain investment in a state. Additionally, when executive compensation is tied to after-tax earnings, executives bear risk associated with a tax law change. Consistent with DTRDs reducing this risk, we find that companies are more likely to use after-tax metrics in executive compensation contracts following the adoption of DTRDs. Our study contributes to ongoing discussions regarding the interplay between financial reporting and tax reporting, highlighting that financial reporting-influenced tax policy can impact companies’ location decisions and executive compensation contracting.

Authors

• Erik Beardsley, University of Illinois

• Brayden Bulloch, University of Wisconsin - Madison

• Michelle Hutchens, University of Illinois at Urbana-Champaign

• Daniel Lynch