Stock Price Reactions to LIFO Adoptions: The Association Between Excess Returns and LIFO Tax Savings

Journal of Accounting Research, Vol. 20, No. 2, 1982

38 Pages Posted: 9 Nov 2010 Last revised: 11 Nov 2010

See all articles by Gary C. Biddle

Gary C. Biddle

University of Melbourne - Faculty of Business and Economics; Columbia Business School; HKU Business School; London Business School

Frederick W. Lindahl

George Washington University - Department of Accountancy

Date Written: April 7, 1982

Abstract

Changes in inventory costing methods, especially those involving the last-in, first-out (LIFO) cost-flow assumption, can generate potentially large changes in a firm's cash flows due to their impact on taxable earnings. These cash-flow effects provide not only a motive for LIFO changes (which is consistent with the market value rule) but also implications for associated stock price effects: if investors react to LIFO's cash-flow implications rather than to its effects on reported earnings, then positive stock price adjustments should be associated with LIFO adjustments. However, it was noted that the previous studies have considered only a dichotomous variable, whether or not a firm has adopted LIFO.

Most firms switching to LIFO now reveal in their financial statement disclosures the tax savings which have been realized. This study uses these disclosures to examine the association between unsystematic returns and the magnitudes of first-year LIFO tax savings for all NYSE firms which adopted or extended their use of LIFO during the period 1972-80. The research design employs within-group comparisons based on cumulative monthly unsystematic (excess) returns with appropriate controls for unexpected earnings performance.

This design avoids several methodological weaknesses inherent in the previous studies and allows more definitive tests of hypotheses relating investor reactions to the income and cash-flow effects of LIFO adoptions. As reported more fully below, results based on LIFO adoptions made in 1974 are consistent with a positive association between cumulative excess stock returns and the magnitudes of LIFO tax savings. The results also provide evidence that changes in systematic risk may accompany LIFO adoptions. However, contrary to previous studies, most of the sample firms exhibit downward rather than upward changes in systematic risk.

Suggested Citation

Biddle, Gary C. and Lindahl, Frederick W., Stock Price Reactions to LIFO Adoptions: The Association Between Excess Returns and LIFO Tax Savings (April 7, 1982). Journal of Accounting Research, Vol. 20, No. 2, 1982, Available at SSRN: https://ssrn.com/abstract=1673110

Gary C. Biddle (Contact Author)

University of Melbourne - Faculty of Business and Economics ( email )

Level 8, Dept of Accounting
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Melbourne, Victoria 3010 3010
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HOME PAGE: http://https://findanexpert.unimelb.edu.au/profile/774767-gary-biddle

Columbia Business School ( email )

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HKU Business School ( email )

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London Business School ( email )

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Frederick W. Lindahl

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
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United States
202-994-5639 (Phone)
202-994-5164 (Fax)

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