Examining Which Tax Rates Investors Use for Equity Valuation

44 Pages Posted: 8 Feb 2014 Last revised: 12 Sep 2017

See all articles by Kathleen Powers

Kathleen Powers

University of Tennessee, Knoxville - College of Business Administration

Andrew Schmidt

North Carolina State University

Jeri K. Seidman

University of Virginia - McIntire School of Commerce

Bridget Stomberg

Indiana University - Kelley School of Business

Date Written: September 10, 2017

Abstract

Although income tax expense is a significant input to valuation models, little empirical evidence exists about which rates investors incorporate. The limited guidance available suggests investors should use the marginal tax rate (MTR), but it is unclear whether investors follow this guidance. We therefore examine the value relevance of simulated MTRs along with tax rates that are less costly to obtain. Across a battery of tests, we find that the top U.S. statutory rate (STR) is more associated with firm value than estimated MTRs, prior-year effective tax rates (ETR), prior three-year average ETRs or prior-year industry-average ETRs. However, we find some evidence that the value relevance of other tax rates increases when those rates reflect firm-specific tax benefits not captured by the STR. This study advances the valuation of tax literature and informs management and standard setters of investors’ use of tax information.

Keywords: Valuation, Tax expense, Stock returns

JEL Classification: G12, M40, M41

Suggested Citation

Powers, Kathleen and Schmidt, Andrew P. and Seidman, Jeri K. and Stomberg, Bridget, Examining Which Tax Rates Investors Use for Equity Valuation (September 10, 2017). Available at SSRN: https://ssrn.com/abstract=2391891 or http://dx.doi.org/10.2139/ssrn.2391891

Kathleen Powers (Contact Author)

University of Tennessee, Knoxville - College of Business Administration ( email )

Haslam Business Building
Knoxville, TN
United States

Andrew P. Schmidt

North Carolina State University ( email )

Raleigh, NC 27695-8113
United States

HOME PAGE: http://https://poole.ncsu.edu/people/apschmid/

Jeri K. Seidman

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

Bridget Stomberg

Indiana University - Kelley School of Business ( email )

1309 East Tenth Street
Indianapolis, IN 47405-1701
United States

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