Communicating Information beyond the Tax Footnote: An Empirical Examination of Effective Tax Rate Forecasts in the MD&A

I investigate management’s decision to voluntarily provide an effective tax rate (ETR) forecast in the Management Discussion and Analysis (MD&A) section of form 10-K. Consistent with my expectations, I find managers initially disclose an ETR forecast in the MD&A when the ETR reported in the current 10-K deviates from the prior year (or years) or when the following year’s ETR is more uncertain. Specifically, I find disclosure of an ETR forecast is more likely when the firm has (1) greater foreign operations, (2) prior period M&A activity, and/or (3) special items. These results are consistent with managers providing additional information in the MD&A when there is more demand from financial statement users for such information. In addition, although I find that managers’ MD&A ETR estimates are conservative, I find that they are superior to forecasts generated using information from current and prior year ETRs. Accordingly, these results lead to a better understanding of firms’ use of the MD&A to communicate tax-related information incremental to the income tax footnote.