How Tax Executives Craft Income Tax Disclosures in Response to Tax-Based Proprietary Costs

We use semi-structured interviews with public company tax executives and archival data to provide new evidence on how tax executives shape the tax footnote in response to their belief that federal, foreign, and state tax authorities use public disclosures in their enforcement efforts. Interviewees express a desire for vague disclosures that nonetheless comply with applicable disclosure mandates. Using a validated measure of “vagueness,” we provide corroborating large-sample evidence that the vagueness of tax footnotes is increasing in tax-based proprietary costs. Additionally, some interviewees convey their belief that vague tax footnotes do not harm investors. We test this conjecture by examining the association between the vagueness of tax footnotes and analyst tax forecast errors. We find only modest evidence that analyst forecast errors are increasing in the vagueness of the tax footnote. However, there are frictions to issuing vague disclosures as we find a positive relation between the vagueness of the tax footnote and the likelihood of receiving an SEC tax comment letter. Our study extends the literature by documenting one way that managers alter tax disclosures in response to tax-based proprietary costs and how this behavior affects stakeholders.