Professor Ed Maydew

Edward Maydew doesn't just teach accounting at UNC Kenan-Flagler; he helps shape public policy on accounting and tax laws. His research has shaped states' economic development policies, confirmed the importance of accounting results to stock prices and discovered that many companies overstating their accounting earnings actually overpaid their taxes as a result.

Professor Ed Maydew

Changing States' Incentives to Encourage Economic Development
Maydew spurred the overhaul of state tax rules with an eye-opening study several years ago. He and Austan Goolsbee, a former colleague at the University of Chicago, found that states could lure manufacturers and other large firms without resorting to generous property tax breaks and other costly financial incentives. Instead, Maydew and Goolsbee showed that states could modify their formulas used to apportion business income to cut taxes on companies with in-state manufacturing plants while hiking taxes on manufacturers that put plants elsewhere.

"Property tax breaks are a fairly expensive way to create jobs," Maydew notes. "We found that states can fiddle with the apportionment formula to encourage or penalize companies…You get a big bang for the buck."

Indeed, the study galvanized state government officials across the United States to act. Maydew and Goolsbee wound up conducting studies for a variety of states and testifying about the economic benefits of their proposed accounting changes. As a result, a number of states, including Illinois and New York, changed their tax laws to put these findings to work.

"It was fun," Maydew says. "A lot of policy people read that paper."

Confirming The Importance of the Balance Sheet for Stock Prices
In another influential study in the late 1990s, Maydew and his team found that, contrary to conventional wisdom at the time, a company's accounting results remained just as relevant to its stock price. Although the correlation between corporate earnings and stock prices had declined over the span of 40 years, the study revealed, the correlation between corporate book values and stock prices had actually increased. So there had been no overall change in accounting's relevance.

"It was very controversial because a lot of people thought earnings had declined in usefulness and because of that accounting as a whole was less useful," Maydew says. "We showed that was only half of the story."

Why Companies Pay Tax on Overstated Earnings
In a third major study, published in 2004, Maydew and scholars from the University of Chicago and the University of Michigan found that while some companies may have illegally overstated their earnings in recent years, most of them wound up paying higher income taxes because of it. Instead, they discovered, most of the 27 firms studied surprisingly paid the higher income taxes seemingly due on their inflated earnings, even though their actual tax load was much lower.

"A large fraction of the companies in our sample did pay taxes," Maydew says. "Some paid at the top marginal rate and some paid at less. It's a mixed bag."

Maydew and his co-authors concluded that many company executives in the sample were willing to trade off the pain of higher taxes for the gain of higher revenues and profits. In other words, the minority of executives willing to commit fraud prefer reporting falsely larger earnings even if it causes their firms to pay heftier tax bills. The researchers argued that this means that Congressional attempts to prevent aggressive accounting practices by boosting the tax costs of overstating earnings may be doomed to failure.

Why would companies willingly pay higher taxes? The authors speculated that the firms in the study most likely did so to avoid raising suspicions about their accounting tricks. When companies report big differences between their book and tax earnings, industry watchers take note.

"The risk would be detection, mainly by smart shareholders, analysts and possibly the IRS," Maydew says. "Why else would you pay taxes that you didn't really owe?"

Maydew, a 38-year-old who came to UNC in 1999 from the University of Chicago, has accounting and taxes in his blood. His father, now retired, was an accounting professor while his brother is a tax lawyer. "It makes for interesting Christmas dinner discussions", he notes with a straight face.