Stephen Lusch, Deloitte-Touche Professor of Accountancy, has published new research in the Journal of the American Taxation Association that challenges long-held assumptions about the impact of Internal Revenue Service (IRS) oversight on corporate equity markets.
The study finds that, contrary to earlier research, increased IRS monitoring can raise a company’s cost of equity. Investors appear to view the possibility of larger tax bills from audits as outweighing the benefits of oversight in curbing managerial risk-taking. The effect is most pronounced for firms that rely on intangible assets to shift income across borders—an approach that often draws heightened scrutiny from tax authorities.
Lusch explained the motivation for the study:
“We decided to pursue this research because we had always been a bit puzzled by the findings in the prior literature. Given improvements in data availability since the earlier work had been published, we felt like we had the opportunity to revisit the prior study's findings to hopefully provide a more complete understanding of the relationship between tax authority monitoring and a firm's cost of equity capital."
The research adds nuance to the debate over tax authority oversight, suggesting that while IRS monitoring may reduce certain managerial risks, it also introduces financial uncertainty that investors factor into stock prices.
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