Investor Response to Tax Related SEC Comment Letters

Abstract

We examine if and when investors systematically respond to SEC comment letters focusing on comment letters that contain tax-related issues. Using a sample of more than 10,000 comment letters from the Audit Analytics' SEC Comment Letter Database, we identify comment letters related to tax issues. Prior research has documented that the receipt of a comment letter can be important to future accounting disclosures but has generally failed to document investor responses. We focus on tax issues as prior research has documented changes in tax paying behavior following the receipt of comment letters by firms. Because of this change in future cash flows, we expect investors to revise their valuations of firms receiving tax related comment letters. We hypothesize, and find evidence consistent with more negative responses to tax related comment letters for tax aggressive firms. Our findings shed light on the role of comment letters in the capital markets and also contribute to the literature on the role of taxes in valuation.

Keywords: Taxes, SEC Comment Letters, Market Reaction, Tax Aggressiveness

JEL Classification: G18, H25, M41