Street vs. GAAP: Which Effective Tax Rate Is More Informative?

Posted: 8 Feb 2021

See all articles by Erik Beardsley

Erik Beardsley

University of Notre Dame - Mendoza College of Business

Michael Mayberry

University of Florida - Fisher School of Accounting

Sean T. McGuire

Texas A&M University - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: September 16, 2020

Abstract

This study investigates how sophisticated market participants use tax-based information by examining whether analysts’ street effective tax rates (ETRs) are informative. When assessing firm performance, analysts exclude items they believe do not reflect current performance, resulting in “street” metrics such as street ETR. However, evidence on the properties of the components of street earnings is limited. Examining the informativeness of street ETRs is important because taxes are a significant component of earnings, and the extent to which analysts understand and incorporate taxes into their analyses is not clear. Using a hand-collected sample of analyst reports, we find that while approximately 35 percent of street ETRs have at least one tax-specific exclusion, over 90 percent reflect the tax effects of pre-tax exclusions. Further, both tax-specific exclusions and the tax effects of pre-tax exclusions significantly contribute to differences between GAAP and street ETRs. Consistent with analysts understanding the implications of tax and non-tax exclusions, our results suggest that street tax metrics exhibit greater predictive ability about future tax outcomes and provide more information to investors than GAAP tax metrics. We also find that ETR exclusions are of higher quality when the magnitude of the potentially excluded item is greater and when managers disclose pro forma earnings. Collectively, our findings suggest that analysts understand taxes, but selectively exert effort to incorporate tax-based information into their assessment of firm performance. Our study should be informative to regulators and users of financial information because it provides evidence regarding the usefulness of street earnings metrics.

Keywords: non-GAAP reporting, street earnings, accounting for income taxes, effective tax rates, analysts, taxes

Suggested Citation

Beardsley, Erik and Mayberry, Michael and McGuire, Sean T., Street vs. GAAP: Which Effective Tax Rate Is More Informative? (September 16, 2020). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3748522

Erik Beardsley (Contact Author)

University of Notre Dame - Mendoza College of Business ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Michael Mayberry

University of Florida - Fisher School of Accounting ( email )

Warrington College of Business
PO Box 117166
Gainesville, FL 32611-7166
United States

Sean T. McGuire

Texas A&M University - Department of Accounting ( email )

430 Wehner
College Station, TX 77843-4353
United States

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