Tax Expense Surprise and Emerging Markets Equity Returns

Abstract

This study investigates the relationship between tax expense surprise and expected equity returns in emerging markets. Using a broad sample of equities from 27 emerging countries, we find a strong positive link between tax expense surprise and the cross-sectional expected stock returns. Univariate portfolio analyses of the overall sample show that equities in the highest tax expense surprise quintile earn 9.48% higher risk-adjusted annual returns than equities in the lowest tax expense surprise quintile. This relationship remains robust to alternative definitions of tax expense surprise, even after controlling for other anomalies related to financial and tax variables in a regression framework. We also examine whether tax enforcement enhances the value relevance of tax expense surprise. The findings show that tax expense surprise is related to expected equity returns only when tax enforcement is high. Thus, tax enforcement plays a significant role in the value relevance of tax expense shocks.

Keywords: tax expense surprise, tax expense momentum, cross-sectional equity returns, emerging markets, international finance

JEL Classification: G10, G11, G12