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Review of Accounting Studies

Erschienen in:

23.02.2017

Book-tax conformity and capital structure

verfasst von: Bradley Blaylock, Fabio B. Gaertner, Terry Shevlin

Erschienen in: Review of Accounting Studies | Ausgabe 2/2017

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Abstract

We examine the effect of increased book-tax conformity on corporate capital structure. Prior studies document a decrease in the informativeness of accounting earnings for equity markets resulting from higher book-tax conformity. We argue that the decrease in earnings informativeness impacts equity holders more than debt holders because of the differences in payoff structures between debt and equity investments such that increases in book-tax conformity lead to increases in firms’ reliance on debt capital. We exploit a natural experiment in the U.S. and find that firms facing an increase in required book-tax conformity increase leverage relative to other firms. We also provide evidence of an increase in the cost of equity (but not of debt) capital for firms facing an increase in required book-tax conformity, relative to control firms, and show that these increases in cost of equity capital are positively associated with an increase in leverage. Our findings are consistent with firms substituting away from equity and toward more debt in the presence of higher book-tax conformity.

Vorheriger Artikel Blockholder exit threats in the presence of private benefits of control

Nächster Artikel Two-stage capital budgeting, capital charge rates, and resource constraints

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Desai (2003, 2005, 2006), Yin (2001), and Whitaker (2005) all suggest moving the taxable income calculation closer to the book income calculation, that is, conforming or basing tax more on the book rules, which is the setting we study.

Exceptions are McClelland and Mills (2007) and Hanlon and Maydew (2009), who examine tax revenue implications of increased book-tax conformity.

Hanlon et al. (2008) were motivated by the findings in Guenther et al. (1997) that firms required to conform taxable income toward accounting income, relative to firms not required to conform, changed their financial reporting behavior in response to the altered tax incentives by deferring more accrual revenue, accelerating more accrual expenses, or both in the post-TRA ‘86 period.

See Graham (2003) for a review of the literature on capital structure and taxes.

According to Hanlon and Heitzman (2010), the EU considered a common consolidated corporate tax base (CCCTB) to be used by all members. One proposal was to link the CCCTB to the common adoption by all EU members of IFRS. However, this proposal met opposition by members who did not want to cede control of their tax base to a foreign entity such as the International Accounting Standards Board.

We use the Blouin et al. (2010) estimates of marginal tax rates to maximize sample size but obtain similar results using pre-interest marginal tax rate estimates from John Graham’s website (see Graham 1996).

The terms “converting firms” and “nonconverting firms” relate specifically to the computation of taxable income. A key benefit of our setting is that all firms (i.e., converting and nonconverting) use the accrual method of accounting to compute book income, regardless of the tax regime. Thus, while book-tax conformity increases for converting firms and stays the same for nonconverting firms, the accrual method of accounting is used for all firms both before and after TRA ‘86.

The five-year pre and post periods reflect a trade-off of wanting sufficient sample observations with concern over confounding events as the sample period increases.

To ensure our regression results are not driven by influential observations, we also eliminate influential observations using the DFFITS statistic (Belsley et al., 1980). After doing so, we find nearly identical results for our leverage and cost of capital tests. We also find similar results after using robust regressions and after eliminating observations with large studentized residuals.

Guenther et al. (1997) report means and medians of sales, assets, and inventory/assets separately across the converting and control firms but pooled across pre and post. Guenther et al. report mean assets for the converting firms of $191 million, which is comparable to our pooled mean of assets. However, the mean assets of $199 million of Guenther et al. for the control firms is much smaller than in Hanlon et al. and our sample.

Unscaled aggregate debt increases from $8.820 billion to $23.467 billion for converting firms and from $350.464 billion to $518.563 billion for nonconverting firms. We note that there are nine times as many firms in the nonconverting sample, compared to the converting sample, and that nonconverting firms are generally larger, which explains the scale difference in aggregate debt.

We use the following model to calculate propensity scores:Converting _i = β ₁ 1/Assets _it + β ₂ Book−to−market _it + β ₃ PP&E _it + β ₄ Return on assets _it + β ₅ Annual stock return _it + β ₆ Marginal tax rate _it + ε_it.

Following matching, we find no differences in means between converting and nonconverting groups for the included covariates indicating covariate balance.

We thank Jennifer Blouin for supplying us with kink data.

Unconditionally, the mean for Kink equals 0.784 for converting firms before TRA ‘86 and 0.942 afterward. The mean for Kink equals 1.255 for nonconverting firms before TRA ‘86 and 1.235 afterward.

We note the general economic stability of our post-TRA ‘86 period complicates the interpretation of this “no result,” as it becomes more difficult to observe increases in bankruptcy in the absence of negative economic shocks.

We obtain 7.6% by dividing the increase in cost of equity for treatment firms relative to control firms (i.e., 1.1%) divided by pre-TRA cost of equity for treatment firms (i.e., 14.4%).

For comparison purposes, we examine the magnitude of a change in the implied cost of equity capital surrounding an increase in noise as proxied by an internal control deficiency. Ashbaugh-Skaife et al. (2009) document an increase in the implied cost of equity of 93 basis points for firms first disclosing an internal control deficiency. They also find a decrease in the average cost of equity of 116 basis points around the release date of an unqualified SOX 404 opinion for firms most likely to report ICDs. We document a 111 basis point increase on average for our converting firms.

We acknowledge that, because measures of cost of debt derived from interest expense capture interest on all debt, rather than new debt, such proxies result in tests that are lower in power relative to tests using interest rates on new debt (which we do not have). However, we try to increase the power of the cost of debt test by limiting our post-TRA ‘86 sample to its last year and find very similar results.

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Titel: Book-tax conformity and capital structure
verfasst von: Bradley Blaylock
Fabio B. Gaertner
Terry Shevlin
Publikationsdatum: 23.02.2017
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 2/2017
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-017-9386-2

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