Implications of the Time-Series Increase in the Relative Informativeness of Taxable Income for Future Earnings and Stock Returns

57 Pages Posted: 6 Oct 2014 Last revised: 31 Mar 2019

See all articles by Sangwan Kim

Sangwan Kim

University of Massachusetts Boston

Allison Koester

Georgetown University

Steve C. Lim

Texas Christian University - M.J. Neeley School of Business

Date Written: December 17, 2015

Abstract

Prior research finds that taxable income is a more useful performance metric when book income quality is low (i.e., the “supplemental information role of taxable income”). We predict and find that taxable income’s supplemental information role for future earnings growth increases over time as book income quality declines over time. This time-series increase in the supplemental information role of taxable income is associated with temporal changes in the market pricing of book-tax differences. We find that mispricing disappears over time in firms where the supplemental information role of taxable income is less pronounced, but persists in firms where the supplemental information role of taxable income is more pronounced. Thus, the complexity of tax-based information and the time-series increase in the supplemental role of taxable income appear to be factors that limit investor learning. Investigating the increase in the supplemental information role of taxable income helps researchers and market participants better understand the time-series implications of two different performance metrics for predicting earnings growth and the equity valuation process as book income quality declines over time.

Keywords: Earnings quality; Earnings growth; Taxable income; Investor learning

JEL Classification: M40, M41

Suggested Citation

Kim, Sangwan and Koester, Allison and Lim, Steve, Implications of the Time-Series Increase in the Relative Informativeness of Taxable Income for Future Earnings and Stock Returns (December 17, 2015). Georgetown McDonough School of Business Research Paper No. 2505739. Available at SSRN: https://ssrn.com/abstract=2505739 or http://dx.doi.org/10.2139/ssrn.2505739

Sangwan Kim (Contact Author)

University of Massachusetts Boston ( email )

100 Morrissey Blvd.
Boston, MA 02125
United States

Allison Koester

Georgetown University ( email )

McDonough School of Business
Washington, DC 20057
United States
202.687.6461 (Phone)

HOME PAGE: http://explore.georgetown.edu/people/apk29/

Steve Lim

Texas Christian University - M.J. Neeley School of Business ( email )

2900 Lubbock Street
Fort Worth, TX 76129
United States
817-257-7536 (Phone)

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