Accounting for Uncertain Tax Positions and Lenders’ Tax Risk Evaluations

This study explores how unrecognized tax benefit (UTB) disclosures are associated with the cost of bank loans. Previous studies have shown that lenders penalize borrowers in the form of a higher cost of bank loans (e.g., Hasan, Hoi, Wu, and Zhang 2014). I extend these studies by investigating how financial reporting related to tax risk, UTB disclosures in particular, is associated with the cost of bank loans. UTB disclosures would be associated with the cost of bank loans for two reasons. First, the UTB balance may signal borrowers’ tax risk, as it represents a potential future obligation to the taxing authorities for an uncertain tax position (FASB 2006a). Second, UTB quality would influence tax risk. When lenders are provided with informative UTB disclosures, they could protect themselves from risk due to uncertain tax positions by predicting the outcome of these positions. In this study, I develop UTB comovement as a measure of UTB quality, and find that both the UTB balance and UTB comovement are associated with the cost of bank loans. While borrowers’ UTB balances increase the cost of bank loans, the degree of increase lowers as UTB comovement increases. In addition, the UTB balance and UTB comovement are more closely related with the cost of bank loans when the ratio of UTB balance to loan amount is above the median. These findings suggest that the cost of bank loans is affected not only by an uncertain tax position, but also by how this uncertain tax position is reported in the financial statement.