Financial restatements, reflecting inaccuracies or manipulations in financial reports, severely impact financial reporting quality. They erode investor trust, introduce uncertainty, and trigger adverse market reactions. While existing research has explored tax information's influence on corporate decision-making (e.g., entrepreneurship, innovation, investment, risk-taking), its effect on financial reporting quality, specifically restatements, remains under-researched. Two competing perspectives exist: increased tax information transparency might deter restatements by enhancing scrutiny, or it might inadvertently increase them by heightening tax burdens and prompting aggressive earnings management. This study aims to resolve this ambiguity by leveraging the phased implementation of CTAIS-3 in China as a natural experiment. CTAIS-3, launched in 2013, represents a significant improvement in China's tax information system. It created a unified technical platform for tax collection, consolidated tax information nationally and provincially to improve data sharing, and facilitated information sharing with third parties like banks and other government agencies. The study's significance lies in addressing the endogeneity challenges inherent in studying the relationship between tax information and restatements through this quasi-experimental design. This approach helps isolate the effects of CTAIS-3 from other potentially confounding factors influencing financial reporting quality and restatements.

Prior research on tax information primarily focuses on its influence on corporate decisions such as entrepreneurship, innovation, investment, and risk-taking. However, the impact of tax information on financial reporting quality, particularly financial restatements, remains less explored. Existing literature suggests that enhanced transparency of tax information might improve financial information quality by increasing the costs associated with inaccurate reporting. However, a counterargument proposes that increased accessibility of tax information might lead to more restatements due to intensified tax scrutiny and potential financial strain on companies, possibly leading to more aggressive earnings management. There is no conclusive evidence on whether the relationship is positive or negative. This study addresses this gap by exploiting the staggered rollout of the CTAIS-3 in China. The literature on information technology's impact on economic issues is also examined. Studies highlight the influence of tax information technology on tax compliance, internal control quality, and financial reporting. However, there is limited research on whether increased access to tax information reduces financial restatements.

The study employs a difference-in-differences (DID) approach using a panel of 3546 publicly listed Chinese firms from 2010 to 2019. The dependent variable is a binary indicator of financial restatement (1 if a restatement occurred, 0 otherwise). The key independent variable is the implementation of CTAIS-3, a binary indicator (1 if CTAIS-3 is implemented in the firm's region, 0 otherwise). The staggered rollout of CTAIS-3 across different regions in China provides the natural experiment. The authors control for various firm-level characteristics (size, profitability (ROA), financial health (leverage), liquidity, investment opportunities (Tobin's Q), and governance (proportion of independent directors)) and province-level characteristics (per capita GDP, fiscal revenue, and average income). The baseline DID regression model incorporates firm and year fixed effects. To address the parallel trends assumption, a dynamic DID model is used, examining the trends in restatements in the years leading up to and following CTAIS-3 implementation. The study further investigates the underlying mechanisms driving the relationship between CTAIS-3 and restatements. The sample is partitioned based on several measures of information asymmetry: stock price synchronicity (reflecting the degree to which firm-specific information is reflected in stock prices), analyst forecast error (reflecting the uncertainty around earnings forecasts), bid-ask spread (reflecting market liquidity and information asymmetry), institutional ownership, and the number of online stock forums. The influence of CTAIS-3 on financial restatements is also studied by comparing State-owned Enterprises and Non-State-Owned Enterprises, and analyzing the effect across different tax avoidance levels, high-tech industries, multinational versus local firms, and large versus small firms. Robustness checks are conducted using alternative proxies for financial reporting quality and different dependent variable specifications. A placebo test is performed to assess the robustness of the findings to unobservable factors.

The study's primary finding is that the implementation of CTAIS-3 is associated with a statistically significant decrease in financial restatements. The baseline DID regression shows a negative and significant coefficient for the CTAIS-3 indicator, indicating a reduction in restatements in treatment firms compared to control firms after the implementation of CTAIS-3. The magnitude of the effect is economically meaningful (around 3.1% reduction). The dynamic DID analysis supports the parallel trends assumption, suggesting that the observed effect is not due to pre-existing trends. The analysis of the underlying mechanisms reveals that the effect of CTAIS-3 on restatements is more pronounced in firms with higher information asymmetry (evidenced by lower stock price synchronicity, higher analyst forecast error, higher bid-ask spreads, lower institutional ownership, and a lower number of online stock forums). Further, the effect is more prominent among Non-State-Owned Enterprises (Non-SOEs) and firms with higher levels of tax avoidance. The impact of CTAIS-3 on financial restatements is also more significant in high-tech firms, multinational companies, and larger firms. Robustness tests using alternative measures of financial reporting quality and a different dependent variable yielded consistent results. A placebo test, where the treatment effect is randomized across firms, confirms the robustness of the results, indicating that the findings are unlikely due to unobservable factors.

The findings provide strong evidence supporting the hypothesis that increased tax information transparency, brought about by the CTAIS-3 system, significantly improves financial reporting quality by reducing the incidence of restatements. The results suggest that improved information availability alleviates information asymmetry between firms and investors, thereby enhancing market monitoring and reducing the incentives for firms to engage in financial misreporting. The stronger effect in firms with higher information asymmetry underscores the importance of the information environment in mitigating opportunistic behavior. The heterogeneous results across firm types and characteristics highlight that the impact of improved tax information systems is contingent on several factors such as firm ownership structure, tax avoidance strategies, and industry characteristics. The study's results are relevant for both academic research and policymaking. They contribute to the literature on the determinants of accounting information quality, the economic consequences of tax information, and the spillover effects of government behavior.

This study demonstrates that the implementation of CTAIS-3 in China led to a significant reduction in financial restatements, particularly among firms with higher levels of information asymmetry. The findings highlight the positive spillover effects of government initiatives aimed at improving tax information transparency on financial reporting quality. This research offers valuable insights for policymakers, regulators, and other stakeholders interested in enhancing corporate financial reporting quality and reducing corporate misreporting. Future research could explore the long-term effects of CTAIS-3, investigate the impact on specific types of restatements, and examine the effectiveness of similar tax information systems in other countries.

The study's focus is on China, limiting the generalizability of the results to other contexts with different institutional settings and regulatory environments. The study relies on publicly available data, potentially omitting unobserved factors that could influence financial reporting quality. The definition of financial restatements used might not capture all forms of accounting irregularities. The study also focuses on publicly listed companies, the results may not be generalizable to privately held firms.