Does mandatory disclosure affect recognition of contingent liabilities? Evidence from FIN 48

Abstract

AbstractThis paper investigates whether mandatory disclosure affects managers’ decisions to recognize contingent tax liabilities. Because of the proprietary nature of tax disclosures, some managers have an incentive to minimize tax reserves and to limit the quality of disclosures, while others prefer to maintain large tax reserves to meet future earnings goals. If large tax reserves are maintained, additional disclosure may be beneficial to reduce information asymmetry between managers and financial statement users. I find that firms which increase tax reserves when they implement FIN 48 are more likely to issue higher quality FIN 48 disclosures. Poor disclosure quality is associated with higher future tax expense suggesting that managers who believe the tax disclosures may be used by tax examiners also want to limit the amount of unrecognized tax benefit reported.