Management Forecast Quality and Corporate Tax Planning: Evidence from the Proprietary Cost Framework

Under the proprietary cost theory, firms voluntarily disclose information when the benefits of disclosure exceed the costs of revealing sensitive information to competitors or regulators. We hypothesize that management guidance may incur proprietary costs by constraining firms’ ability to pursue aggressive tax strategies and exposing internal performance expectations to tax authorities. Using 18,051 firm-year observations of U.S. public firms from 1993 to 2020, we measure management guidance quality by forecast accuracy and aggressive tax planning by effective tax rates, book–tax differences, discretionary permanent book–tax differences, the ETR differential, and a composite factor score of these measures. We find that management guidance quality is negatively associated with aggressive tax planning. Consistent with the notion that higher-quality management guidance enhances the dissemination of firm-specific information and facilitates regulatory scrutiny, we find that greater IRS attention strengthens the negative association between management forecast accuracy and aggressive tax planning in the subsequent year. To mitigate endogeneity concerns, we exploit an instrumental variable approach with industry peers’ forecast frequency as an instrumental variable and confirm the negative impact of forecast accuracy on tax aggressiveness. Overall, our findings highlight an important role of management guidance quality in corporate tax planning and contribute to the literature on the intersection of corporate disclosures and tax planning strategies.