The effect of mandatory disclosure of tax uncertainty on investment efficiency : evidence from FIN 48

Abstract

This paper examines the effect of mandatory disclosure of tax uncertainty on corporate investment efficiency. Based on a sample of firms that disclose uncertain tax benefits (UTBs) in their financial statements after the regulatory requirements under Financial Interpretation No. 48 (FIN 48), I find that, after FIN 48, firms claiming uncertain tax benefits (i.e., affected firms) experienced a significant decrease in investment efficiency relative to firms that do not have uncertain tax positions (i.e., non-affected firms). The results are consistent using alternative propensity score matched (PSM) sample and robust to different PSM design choices and entropy balancing matching approach. This study also documents a larger drop in capital issuances for affected firms following FIN 48 adoption. These findings suggest that the disclosure of tax uncertainty alters capital suppliers’ perceptions of the riskiness of future cash flows engendered by tax aggressiveness and thus reduces investment efficiency of these affected firms through limited external financing. In cross-sectional tests, I find the effect to be more pronounced for tax uncertainty firms that are more likely to be subjected to tax audit and challenged by the tax authority (i.e., firms reporting higher level of UTBs and firms with mobile income), and firms that are more financially constrained.