Do Firms Use Tax Reserves to Meet Analysts’ Forecasts? Evidence from the Pre- and Post-FIN 48 Periods

We examine whether firms use tax reserve decreases to meet analysts’ quarterly earnings forecasts in the period prior to the passage of FIN 48 and whether that behavior changed following the enactment of FIN 48. In the pre-FIN 48 period, we observe that firms reduce their tax reserves (i.e., increase income) when pre-managed earnings are below analysts’ forecasts. Specifically, we find that approximately 78% of firm-quarters that missed the earnings target without the benefit of the tax reserve decrease subsequently meet the earnings target after including the benefit. Further, we find that the amount of the decrease in the tax reserves is significantly associated with the magnitude of the deviation between pre-managed earnings and analysts’ forecasts. In contrast, in the post-FIN 48 period we do not find any evidence that firms use changes in the tax reserves to manage earnings around analysts’ forecasts. Thus, our results suggest that FIN 48 has, at least initially, curtailed earnings management through the tax reserves