Sustainable Tax Strategies and Earnings Persistence

Abstract

This study examines whether the sustainability of a firm’s tax strategy provides information about the persistence of a firm’s pre-tax earnings and earnings components. We also investigate whether investors are able to determine the sustainability of a firm’s tax strategy and use it as a signal to correctly price the persistence of a firm’s pre-tax earnings and earnings components. Sustainability is an additional dimension of a firm’s tax strategy that focuses on maintaining consistent tax avoidance outcomes over time. Consistent with the sustainability of a firm’s tax strategy providing unique information about earnings persistence and reflecting managers’ expectations of future earnings, we find that firms with more sustainable tax strategies exhibit more persistent pre-tax earnings and earnings components. We also find that investors are able to infer the sustainability of a firm’s tax strategy and use it as a signal to assess the persistence of pre-tax earnings and earnings components.

Keywords: sustainable tax strategies, earnings persistence, earnings expectations

JEL Classification: M40, M41, M49