American Taxation Association
JATA - 2002 Supplement
Volume 24 supplement
CEO Bonus Pay, Tax Policy, and Earnings Management
The Interrelationship between Estimated Tax Payments and Taxpayer Compliance
The Effect of the Expected Holding Period on the Market Reaction to a Decline in the Capital Gains Tax Rate
Equity Price Pressure from the 1998 Reduction in the Capital Gains Holding Period
Austin Reitenga, Steve Buchheit, Qin Jennifer Yin and Terry Baker
In 1993, Congress passed Internal Revenue Code Section 162(m), which eliminated the tax deductibility of nonperformance-based executive compensation over $1 million. Recent research indicates that, as intended, Code Section 162(m) has strengthened the link between executive pay and firm performance.
Although 162(m) apparently has changed executive compensation in a way desired by Congress, we hypothesize that 162(m) has indirectly influenced the financial-reporting process. Specifically, we hypothesize and find evidence to support the following: for numerous reasons associated with "qualifying" a compensation plan per Code Section 162(m), executives in firms that qualify their compensation plans receive relatively low pay when their firm's financial performance is extreme. Because these executives receive relatively low pay for extreme financial performance, an incentive exists to smooth reported earnings over time in order to maximize long-term compensation. The relatively smooth earnings patterns that we observe in qualified firms are related to the use of discretionary accruals.
Our results appear robust to alternative sampling and modeling techniques. As such, our evidence suggests that a tax policy designed to curb allegedly excessive executive compensation has indirectly affected the quality of reported earnings. Top
Glenn D. Feltham and Suzanne M. Paquette
This paper examines taxpayers' compliance behavior and the tax agency's audit decision in a broader, more realistic, setting. Whereas prior research has taken the taxpayer's prepayment position as exogenous, this study extends the literature by incorporating the estimated tax payment decision into a tax compliance game. A two-period game-theoretic model is used to examine the effect that the estimated tax payment rules have on taxpayers' incentives to evade and on the tax agency's audit strategy.
Our primary results are as follows. First, in equilibrium taxpayers' estimated tax payment decision will depend upon the uncertainty about their true tax liability, and the cost from overpayment (the taxpayer's cost of capital) or underpayment (penalty interest) of installments of estimated tax. Second, under reasonable assumptions, high-type taxpayers who make higher installments of estimated tax are less likely to lie about their level of income than those who make lower installments—that is, taxpayers who pay low are more likely to evade. Third, the tax agency audits taxpayers who have made low reports and low estimated tax payments with a higher probability than those who have made high estimated tax payments. The gain to the tax agency from auditing taxpayers who make lower payments and evade arises not only from the penalties charged for evasion, but also from the interest charged on deficient installments of estimated tax. Top
Jia-Wen Liang, Steven R. Matsunaga and Dale C. Morse
We use the market reaction to capital gains tax rate reduction in the 1997 Tax Relief Act to investigate the market reaction to a change in investor-level tax rates. We find that the positive market reaction was lower for dividend-paying securities and securities with longer expected holding periods. Our results also support the hypothesis that a longer expected holding period reduces the impact of the dividend-paying status. These results are consistent with the tax capitalization model and suggest that the expected holding period is a significant variable in explaining the market reaction to a change in capital gains tax rates. Top
Jennifer L. Blouin, Jana Smith Raedy and Douglas A. Shackelford
This paper provides evidence consistent with shareholders' personal tax incentives affecting stock prices and trading volume. On June 24, 1998, the marginal tax rate on capital gains was reduced from 28 percent to 20 percent for individual investors holding shares between 12 and 18 months. This study compares firms whose initial public shareholders immediately benefited from the reduction to other IPO firms. The sample of immediately affected firms recorded mean, incremental, one-day stock price declines of –1.3 percent amid heavy trading. The results are consistent with capital gains tax planning constraining investment portfolio management. When the constraint was lifted, enough shareholders sold that prices moved. The results imply that despite increasingly liquid capital markets, transaction costs remain large enough to prevent investors from entering the market immediately and fully offsetting downward price pressure from individual capital gains tax management. Top