The impact of intangibles on accounting conservatism, audit pricing, and tax avoidance

Abstract

In Chapter 3, I examine the effect of a creative corporate culture on tax avoidance. I construct a novel measure for creative corporate culture using textual analysis of public firms’ 10-K reports and find that firms with a more creative culture are more likely to engage in tax avoidance. This effect is incremental to previously documented effects of research and development (R&D) and intangibles (e.g., patents) on tax avoidance. I successfully perform multiple validation tests and robustness tests to strengthen the hypothesized link between creative culture and tax avoidance. The results also show a causal relationship through an instrumental variables approach, using CEO’s degree centrality. The study identifies a new environmental factor (i.e., creative corporate culture) that affects corporate tax planning.

In this dissertation consisting of three chapters, I explore the impact of several intangible aspects of firms, such as corporate culture and IRS monitoring, on company financial policies. In the first chapter, I study the effects of IRS attention on a firm’s degree of unconditional conservatism; in the second chapter, I study the effects of collaborative culture on audit pricing; and in the third chapter, I study the effects of creative culture on tax avoidance.

In Chapter 1, I explore whether firms institute a higher degree of accounting conservatism in response to IRS monitoring. Utilizing textual analysis to obtain data on IRS acquisition of public firms’ 10-K financial disclosures in order to proxy for IRS attention, I find that when firms are under IRS attention, they tend to initiate higher levels of unconditional accounting conservatism. This effect holds for conditional accounting conservatism as well as several robustness tests and subsample analyses. The results also show a causal effect after using a difference-in-differences model with propensity score matching to match treatment firms that received an exogenous shock (IRS attention) to control firms that did not receive that shock within the sample period. This chapter provides insight into how firms attempt to mitigate the risk resulting from the IRS monitoring of their financial statements.

In Chapter 2, I examine whether auditors consider their clients’ corporate cultures in their audit pricing. I construct a measure for corporate collaborative culture using textual analysis of public firms’ 10-K reports and find that firms with a more collaborative culture pay lower audit fees. I argue that firms with a culture of collaboration emphasize harmony among their employees, leading to lower litigation risk, which lowers auditor risk premiums. A collaborative culture also encourages employee reporting of errors and problems, leading to lower control risk and reducing risk premiums. My findings from path analysis and a structural equation model support the proposed argument. Moreover, I rule out alternative explanations for reduced pricing, such as reduced audit quality and significant auditor changes. The negative relationship between collaborative culture and audit fees holds in a difference-in-differences model using mergers and acquisitions as exogenous shocks to corporate culture. The finding is also robust to multiple alternative measures of collaborative culture.