Showing papers by "Dan S. Dhaliwal published in 2003"

Last Chance Earnings Management: Using the Tax Expense to Achieve Earnings Targets

Abstract: We assert that the tax expense is a powerful context in which to study earnings management, because it is one of the last accounts closed prior to the earnings announcement. While many pre-tax accruals must be posted in the year-end general ledger, managers estimate and negotiate tax expense with their auditors immediately prior to the earnings announcement. We hypothesize that changes from 3rd to 4th quarter effective tax rates (ETRs) are negatively related to whether and how much a firm's earnings absent tax expense management miss analysts' consensus forecast, a proxy for target earnings. We measure earnings absent tax expense management as actual pretax earnings adjusted for the annual ETR reported at the third quarter. We provide robust evidence that firms lower their projected ETRs when they miss the consensus forecast, consistent with firms decreasing their tax expense if non-tax sources of earnings management are insufficient to achieve targets. We also find that firms that exceed earnings targets increase their ETR, but this effect is smaller. By studying the tax expense in total, rather than narrow components of deferred tax expense, our results provide general evidence that reported taxes are used to manage earnings.

Dividend Taxes and Implied Cost of Capital

Abstract: We estimate firms' implied cost of capital and examine the effects of dividend taxes on this ex ante measure. The results support the dividend tax capitalization hypothesis. We find a positive relation between implied cost of equity capital and dividend yield that is decreasing in aggregate institutional ownership. We further explore the effect of institutional ownership on the dividend tax premium by partitioning institutional owners into groups of homogeneous investors. We find evidence that ownership by certain groups of tax-favored institutions, including insurance companies, endowments, and pensions, decreases the dividend tax premium and that ownership by mutual funds, non-tax-favored institutions, does not significantly affect the dividend tax premium. Although banks do not face the dividend tax penalty that individual investors face, we do not find that the dividend tax premium is decreasing in ownership by banks, contrary to our predictions. We believe that this exploration paves the way for future research that can identify stronger settings within which to examine the effects of institutional owners' tax attributes on the dividend tax premium.

Is a Dividend Tax Penalty Incorporated into the Return on a Firm's Common Stock?

Abstract: We find that a firm's dividend yield has a positive impact on its common stock return that is decreasing in the level of institutional and corporate ownership, our indicator of whether the marginal investor in a firm's common stock is more likely to be a low-tax or a high-tax investor. These results suggest that 1) a dividend tax penalty is incorporated into the return on a firm's common stock and 2) both a firm's dividend policy and its ownership structure impact the size of the dividend tax penalty.

Costly Public Disclosure and the Choice Between Private and Public Debt

Abstract: This paper examines the implications of costly public disclosure within the context of a firm’s financing choice between private and public debt. Because private debt avoids costly public disclosure, extant theory posits that firms who discern disadvantages in disclosing firm-specific information publicly will find it cost efficient to raise funds in private debt markets. Using a sample of new debt issues, we find that firms are more likely to issue private debt when disclosure costs are high. We complement these results by also examining the relation between the mix of private and public debt claims in firms’ capital structure and disclosure costs. Consistent with theory, we find the level of private debt claims outstanding increases with the level of disclosure costs. Overall, our results hold after controlling for the endogeneity of firms’ disclosure policy. Our results are also robust to the inclusion of firm characteristics that have been posited by theory to influence the choice between private and public debt. Costly Public Disclosure and the Choice between Private and Public Debt