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Interim Effective Tax Rate Estimates and Internal Control Quality

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  • Sean T. McGuire
  • Stevanie S. Neuman
  • Sarah C. Rice

Abstract

This study examines whether the volatility of interim estimates of the annual effective tax rate (ETR) provides ex ante information about the quality of firms' internal control environments. Recent research suggests that some firms selectively disclose internal control weaknesses (ICWs). Given the negative consequences associated with ICWs, it is important for capital market participants to be able to identify firms with ineffective internal controls in a timely manner. We find that firms with more volatile annual ETR estimates are more likely to report both tax‐ and nontax‐related ICWs in the current year. Our results also indicate that the volatility of annual ETR estimates declines following the remediation of tax‐related ICWs, but not following the remediation of nontax‐related ICWs. In addition, we find that ETR volatility in the current year is associated with the likelihood that a firm will report an ICW in the following year. Finally, we provide evidence that the volatility of annual ETR estimates is associated with the likelihood that a firm has an undisclosed ICW. In combination, our results suggest that the volatility of interim estimates of the annual ETR provides an ex ante signal of the likelihood that a firm's internal controls are ineffective. Estimations provisoires du taux d'imposition effectif et qualité du contrôle interne Les auteurs se demandent si la volatilité des estimations provisoires du taux d'imposition effectif (TIE) annuel fournit de l'information anticipée au sujet de la qualité de l'environnement de contrôle interne des sociétés. Selon de récentes études, certaines sociétés communiquent de manière sélective l'information relative aux faiblesses du contrôle interne. Compte tenu des répercussions négatives associées à ces faiblesses, il importe pour les participants aux marchés de capitaux de pouvoir repérer rapidement les sociétés dont le contrôle interne est inefficace. Les auteurs constatent que les sociétés dont les estimations du TIE annuel sont plus volatiles sont davantage susceptibles de faire état de faiblesses du contrôle interne, que ces faiblesses soient liées ou non à l'impôt, dans l'année courante. Les résultats qu'obtiennent les auteurs indiquent également que la volatilité des estimations du TIE annuel décline une fois corrigées les faiblesses du contrôle interne lorsque ces faiblesses sont liées à l'impôt mais non lorsqu'elles ne le sont pas. Ils relèvent en outre que la volatilité du TIE dans l'année courante est associée à la probabilité qu'une société fasse état d'une faiblesse du contrôle interne l'année suivante. Enfin, ils démontrent que la volatilité des estimations du TIE annuel est associée à la probabilité qu'une société ait une faiblesse du contrôle interne dont elle n'a pas fait état. Dans l'ensemble, les résultats de l'étude paraissent indiquer que la volatilité des estimations provisoires du TIE annuel donne un signal précurseur de la probabilité que le contrôle interne d'une société soit inefficace.

Suggested Citation

  • Sean T. McGuire & Stevanie S. Neuman & Sarah C. Rice, 2020. "Interim Effective Tax Rate Estimates and Internal Control Quality," Contemporary Accounting Research, John Wiley & Sons, vol. 37(1), pages 603-633, March.
    • Handle: RePEc:wly:coacre:v:37:y:2020:i:1:p:603-633
    DOI: 10.1111/1911-3846.12527
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    References listed on IDEAS

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