Disclosure of corporate tax reports, tax enforcement, and price information

Abstract

• We investigate the consequences of public disclosure of tax return information. • Managers report profits and trade according to the disclosed information. • The information content of stock prices varies with the tax disclosure regime. • Tax report disclosure improves market performance but can reduce tax revenue. • Our findings are relevant for policy makers in the tax disclosure debate. This paper analyzes the effects of disclosing corporate tax reports on both financial markets’ performance and tax revenue. To this end, we characterize the optimal auditing policy of the tax enforcement agency and the optimal tax reporting strategy of a firm. The manager of the firm has the possibility of trading in the firm’s stock and, therefore, he cares about the information disclosed through the tax report. Our analysis suggests that, despite disclosure of the tax reports being beneficial for market performance (as the spread is 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. We also draw empirical and policy implications about the effect of the tax agency's efficiency on both trading costs and net tax collection. Our results shed light on the debate about the costs and benefits of disclosure.