The Nonlinear Relation between Effective Tax Rates and Tax-Related Restatements

Abstract

We examine the association between firms' tax planning behavior, as measured by their effective tax rates (ETRs), and financial restatements. We find that both low and high ETRs are positively related to subsequent tax-related restatements, indicating a nonlinear relation between ETRs and tax-related financial reporting quality. We also find evidence that tax-related restatements for low ETR firms reflect increased operational complexity that pervades the firm and results in an increased likelihood of tax and non-tax restatements. High ETR firms, in contrast, appear to suffer from inadequate controls and expertise surrounding the reporting for income taxes. We do not find evidence that this extends outside the tax function to other types of restatements. All results hold after controlling for internal control weaknesses and other characteristics known to affect ETRs and the likelihood of restatements.