Abstract
In this paper, we analyze the effects of disclosing corporate tax reports on the performance of financial markets and the use of asset prices by the tax enforcement agency in order to infer the true corporate cash flows. We model the interaction between a firm and the tax auditing agency, and highlight the role played by the tax report as a public signal used by the market dealer and the role of prices as a signal used by the tax authority. We discuss the determinants of both the reporting strategy of the firm and the auditing policy of the tax authority. Our model suggests that, despite disclosure of the tax reports being beneficial for market performance (as the spreads and trading costs are smaller than under no disclosure), the tax agency might have incentives to not disclose the tax report when its objective is to maximize expected net tax collection.
Highlights
In this paper, we study whether is desirable or not to make firm’s tax statements public
We have developed an insider trading model that has allowed us to analyze how an endogenous public signal resulting from the interaction between a firm and a tax auditing agency may affect trading in the financial market
We show that uncertainty regarding a firm’s payoff realization, together with the endogeneity arising during the reporting stage, has a sizeable impact on the reporting strategy of the firm, the auditing policy of the tax agency, and the pricing policy adopted by the dealer in the financial market
Summary
We study whether is desirable or not to make firm’s tax statements public. In 2012 the President Obama’s Framework for Business Tax Reform called for an increase in disclosure of annual corporate income tax: “Corporate tax reform should increase transparency and reduce the gap between book income, reported to shareholders, and taxable income reported to IRS. These reforms could include greater disclosure of annual corporate income tax payments.” As Hasegawa et al (2013) point out, this debate took place in the complete absence of empirical evidence of taxpayers responses to income tax disclosure and in the absence of any theoretical framework that could show the effects of the public disclosure of the corporate tax report. Aims to fill in partially the lack of theoretical models that study the effect of disclosure of the tax report on financial markets and on tax compliance
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