The Impact of Private Equity Ownership on Corporate Tax Avoidance

This study investigates whether private equity (PE) firms influence the tax practices of their portfolio firms. Prior research documents that PE firms create economic value in portfolio firms through effective governance, financial, and operational engineering. Given PE firms' focus on value creation, we examine whether PE firms influence the extent and types of tax avoidance at portfolio firms as an additional source of economic value. We document that PE-backed portfolio firms engage in significantly more nonconforming tax planning and have lower marginal tax rates than other private firms. Moreover, we document that PE-backed portfolio firms pay 14.2 percent less income tax per dollar of pre-tax income than non-PE backed firms, after controlling for NOLs and debt tax shields. We find additional tax savings for PE-backed portfolio firms that are either majority-owned or owned by large PE firms, consistent with PE ownership stake, expertise, and resources serving as important factors in the tax practices of portfolio firms. We infer that PE firms view tax planning as an additional source of economic value in their portfolio firms, where the benefits outweigh any potential reputational costs associated with corporate tax avoidance.Private equity, ownership structure, tax avoidance, tax planning, tax aggressiveness, book-tax differences.

Externalities of public firm presence: Evidence from private firms' investment decisions

Public firms provide a large amount of information through their disclosures. In addition, information intermediaries publicly analyze, discuss, and disseminate these disclosures. Thus, greater public firm presence in an industry should reduce uncertainty in that industry. Following the theoretical prediction of investment under uncertainty, we hypothesize and find that private firms are more responsive to their investment opportunities when they operate in industries with greater public firm presence. Further, we find that the effect of public firm presence is greater in industries with better information quality and in industries characterized by a greater degree of investment irreversibility. Our results suggest that public firms generate positive externalities by reducing industry uncertainty and facilitating more efficient private firm investment.MIT Junior Faculty Research Assistance ProgramErnst & YoungPrice Waterhouse (Firm)University of Notre Dam

Verification Services and Financial Reporting Quality: Assessing the Potential of Review Procedures

Are financial statement reviews, which are limited to primarily analytical procedures and inquiries, a cost-effective verification service for some firms? The answer is important for owner/managers considering reviews as well as investor/lenders, regulators, and those interested in effective verification mechanism design. Using data from U.S. private companies choosing to have financial statements compiled, reviewed, or audited, we calculate four model-based financial reporting quality proxies and, to reflect broader economics, the cost of debt and verification fee estimates. Consistent with application of prescribed verification procedures, we find both reviews and audits yield significantly better reporting quality scores and lower cost of debt than zero-verification compilations. However, model-based reporting quality scores of reviews and audits are indistinguishable statistically, on average. Regarding broader economics, we find that relative to compilations, reviews yield more than half the added interest rate benefit associated with an audit, at considerably less than half the added cost. Overall, our results suggest reviews may provide a cost-effective verification alternative to audits, and the potential of analytical procedures warrants more attention by audit researchers and regulators

Public equity and audit pricing in the U.S.

Does audit pricing of U.S. firms with publicly traded equity differ from pricing of otherwise similar, firms with private equity?. The answer is potentially important for evaluating for regulatory regime design efficiency and for understanding audit demand and production economics. For U.S. firms with publicly- traded debt, we hold constant the regulatory regime, including issuer reporting mandates as well as auditor responsibilities and practices. We thus vary equity, ownership factors and public securities market factors plus any related de facto litigation risk and audit demand. In cross-section, we find that audit fees for public equity firms 12% to 25% higher than fees for similar private equity firms. Time-series comparisons for firms that change owners hip status yield larger percentage fee increases (decreases) for those going public (private). Results are consistent with substantial incremental audit fees arising from higher auditor litigation risk associated with public equity ownership