Double Trouble? IRS's Attention to Financial Accounting Restatements

Abstract

We examine whether the IRS uses public information to obtain qualitative signals regarding the quality of firms’ financial information or management integrity. Using the procurement of public information as a proxy for IRS attention, we test whether public signals of poor information quality (restatements) lead to an increase in IRS attention. To begin, we document that the IRS is both more likely and quicker to acquire public filings announcing a restatement than any other filing of the firm. Furthermore, we examine instances in which the IRS is more likely to learn of a restatement and find an increase in attention around both press releases and media coverage of the restatement. Next, we examine the implications of increased IRS attention. Employing path analysis, we find that IRS attention is associated with both higher levels of future tax settlements, and a greater likelihood of the mention of a tax audit. Overall, our results are consistent with the IRS responding to signals of poor information quality or management integrity as if financial misreporting and tax reporting are related.