The Valuation Implications of a Firm's Ability to Mitigate or Sustain the Effects of Tax Law Changes

Abstract

This study examines the valuation implications of the ability of firms to mitigate tax increases or sustain tax decreases. We propose that some firms are able to mitigate increases in taxes faster and sustain decreases in taxes longer than other firms. We investigate that conjecture by decomposing earnings and isolating the tax change component. Our results indicate that the securities markets expect strong (weak) firms to bear a lesser (greater) share of the tax burden when effective tax rates are increased and to receive a greater (lesser) share of the tax benefit when effective tax rates are decreased.

JEL Classification: M41, K34, G12