Imagine you’re a baseball pitcher in the early innings against a hot-hitting team. Testing the umpire’s strike zone, you hurl an inside pitch that nearly hits the batter. The home plate umpire, fairly or not, interprets it as an attempted intentional beanball, and issues a warning that he’s watching you closely now – and further pitches like that won’t be tolerated. So for the rest of the game, you make up for it by adjusting your pitch placement and avoid further scrutiny.
That’s something like how major companies behave when filing their taxes a year after being flagged with a “comment letter” by the Securities and Exchange Commission. While pitchers tend to alter the location of their fastballs and curveballs under the ump’s watchful eye to keep the peace, public companies tend increase their tax payments after receiving notice from the SEC, new research from the University of Nebraska-Lincoln has shown.
The study, co-authored by Professor of Accounting Tom Omer, showed that agencies that get a comment letter from the SEC after the regulatory agency peeks at their tax disclosures are inclined to increase their tax compliance the following year. So, too, do their corporate peers.
Omer and the study’s three co-authors said that is an unintended consequence of getting better information to investors by the SEC – and results in firms paying up to $3 billion of additional federal, state and foreign government taxes in a single year.
The Sarbanes-Oxley Acts of 2002 directs the SEC to review financial reports of companies every three years. If filings appear deficient or need clarification, the SEC issues comment letters asking for more information to help investors sort through a company’s financial details.
“The SEC is solely responsible for how firms present financial statements to investors, and not about whether companies are paying their taxes,” said Omer, the Delmar Lienemann Sr. Chair of Accounting in the College of Business Administration. “The comment letters occur when the SEC demands more clarity in financial disclosures. There is real tension that goes on when those requests are made.”
The study found that after a company received a comment letter dealing with taxes, it typically increased its provision for income taxes by about 1.4 percentage points and their actual cash payments by 1.5 percentage points.
The researchers reviewed nearly 3,000 comment letters over nine years, of which about 30 percent dealt with tax issues. Though the letters were not sent with direct intent to increase tax payments, the study’s findings lent evidence that the letters have wide-ranging effects.
“Even if a company did not get a comment letter, they probably still react when firms in the same industry get them,” Omer said. “They see similar companies targeted for non-disclosure and tend to migrate to like positions. More disclosure drives firms to be careful regarding paying taxes.”
While the SEC and Internal Revenue Service do not communicate directly, the work the SEC provides creates a connection, he said.
“Corporations are very sensitive about turning over information on taxes. They must be somewhat concerned it will draw in another agency to start asking questions,” he said.
The study, “The Effects of Regulatory Scrutiny on Tax Avoidance: An Examination of SEC Content Letters,” appeared in The Accounting Review, the top journal for accounting research. Co-authors are Daniel Lynch of the University of Wisconsin, Michael Mayberry of the University of Florida and Thomas Kubick of the University of Kansas, who earned a doctorate in accounting from Nebraska’s School of Accountancy in 2011.