Earnings Persistence and Stock Market Reactions to the Different Information in Book-Tax Differences: Evidence from China

The International Journal of Accounting, Forthcoming

45 Pages Posted: 3 Jan 2008 Last revised: 30 Sep 2011

See all articles by Tanya Y. H. Tang

Tanya Y. H. Tang

Brock University

Michael Firth

Lingnan University - Department of Finance and Insurance

Date Written: September 30, 2011

Abstract

Prior studies document that book-tax differences (BTDs) reflect divergent reporting rules for book and tax purposes, and contain information about earnings management and tax planning. In this paper we investigate whether the regulatory and opportunistic information impounded in BTDs differentially influences earnings persistence and the earnings-returns relation. Using BTD data from China, we separate BTDs into normal BTDs (NBTDs) and abnormal BTDs (ABTDs). NBTDs are more likely driven by regulatory differences between accounting and tax rules and ABTDs are more likely driven by earnings and tax management activities. We find that firms with large positive and negative ABTDs (NBTDs) exhibit less earnings persistence compared to firms with small ABTDs (NBTDs). However, the level of earnings persistence for large unsigned ABTD firms is significantly lower than that for large unsigned NBTD firms. While large unsigned NBTDs appear to enhance the earnings-returns relation, we find no evidence that large unsigned ABTDs affect the earnings-returns relation. Overall, the results suggest that the differing components of BTDs have differential implications for earnings quality. Additional tests show that ABTDs and NBTDs can provide incremental information about earnings persistence beyond the information in discretionary accruals and total accruals, suggesting that the investigation of BTDs adds value to financial analysis.

Keywords: book-tax-differences, earnings and tax management, earnings persistence, earnings quality, stock returns

JEL Classification: G12, G29, H25, M41, M43

Suggested Citation

Tang, Tanya Y. H. and Firth, Michael, Earnings Persistence and Stock Market Reactions to the Different Information in Book-Tax Differences: Evidence from China (September 30, 2011). The International Journal of Accounting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1080359

Tanya Y. H. Tang (Contact Author)

Brock University ( email )

500 Glenridge Ave.
St. Catherines, On L2S 3A1
Canada

Michael Firth

Lingnan University - Department of Finance and Insurance ( email )

Castle Peak Road
Tuen Mun, New Territories
Hong Kong
China
+852 2616 8160 (Phone)
+852 2466 4751 (Fax)

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