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Book-Tax Differences, Uncertainty about Fundamentals and Information Quality, and Cost of Capital

53 Pages Posted: 16 Jul 2008 Last revised: 29 Aug 2014

Dan S. Dhaliwal

University of Arizona - Department of Accounting

Robert E. Huber

University of Arizona - Department of Accounting

Hye Seung Lee

Fordham University - Accounting Area

Morton Pincus

University of California, Irvine

Date Written: November 11, 2008

Abstract

Prior research suggests that differences between book and taxable incomes reflect firms' underlying economic fundamentals and their earnings management activities. We investigate the extent to which book-tax differences (BTDs) explain differences in cost of equity capital across firms. Our analysis spans the 1982-2006 period. The results indicate that variability in BTDs estimated over five or six years is positively and significantly related to cost of equity capital (estimated in various ways), whereas other BTD variables generally are not. These findings are consistent with variability in BTDs over time capturing information regarding uncertainty about firms' economic fundamentals and uncertainty about the quality of their earnings. If we assume that only a relatively short time-series of data is available, then we find that the absolute value of BTDs is positive and significantly related to cost of capital.

Keywords: Variability of book-tax differences, innate characteristics, information uncertainty

JEL Classification: M41, M43, H25, G12

Suggested Citation

Dhaliwal, Dan S. and Huber, Robert E. and Lee, Hye Seung and Pincus, Morton, Book-Tax Differences, Uncertainty about Fundamentals and Information Quality, and Cost of Capital (November 11, 2008). Available at SSRN: https://ssrn.com/abstract=1127956 or http://dx.doi.org/10.2139/ssrn.1127956

Dan S. Dhaliwal (Contact Author)

University of Arizona - Department of Accounting ( email )

McClelland Hall
PO Box 210108
Tucson, AZ 85721
United States

Robert E. Huber

University of Arizona - Department of Accounting ( email )

Tucson, AZ 85721
United States

Hye Seung Lee

Fordham University - Accounting Area ( email )

Graduate School of Business
113 W. 60th Street
New York, NY 10023
United States

Morton P.K. Pincus

University of California, Irvine ( email )

Irvine, CA 92697-3125
United States
949-824-4062 (Phone)
949-725-2812 (Fax)

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