Street vs. GAAP: Which Effective Tax Rate Is More Informative?
57 Pages Posted: 7 Apr 2020
Date Written: March 2020
This study investigates how sophisticated market participants use tax-based information by examining whether analysts’ street effective tax rates (ETRs) are informative. When forecasting and assessing firm performance, analysts often exclude certain items they believe do not reflect current performance, resulting in “street” metrics such as street ETR. Using a hand-collected sample of analyst reports, we find that approximately 35 percent of street ETRs have at least one tax-specific exclusion, and over 90 percent have tax effects of pre-tax exclusions. Consistent with analysts’ understanding the implications of tax and non-tax exclusions, our results suggest that street ETRs are more informative than GAAP ETRs. We investigate variation in analysts’ ETR exclusions and find that ETR exclusions are of higher quality when the magnitude of the potential excluded item is greater and when managers disclose pro forma earnings. These results provide a nuanced view of the extent that analysts incorporate tax-based information into their assessment of firm performance. Collectively, our findings suggest that analysts understand taxes, but selectively exert effort to understand and incorporate tax-based information into their assessment of firm performance.
Keywords: Non-GAAP reporting, street earnings, accounting for income taxes, effective tax rates, analysts
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