The Persistence and Pricing of Earnings, Accruals, and Cash Flows When Firms Have Large Book-Tax Differences

56 Pages Posted: 4 Mar 2003

See all articles by Michelle Hanlon

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: December 2002

Abstract

I investigate the role of book-tax differences in indicating the persistence of earnings, accruals and cash flows for one-period-ahead earnings. I also examine whether the level of book-tax differences influences investors' assessments of future earnings persistence. I find that firm-years with large book-tax differences have earnings which are less persistent than firm-years with small book-tax differences. Further, the evidence is consistent with investors interpreting large positive book-tax differences (book income greater than taxable income) as a "red flag" and reducing their expectation of future earnings persistence for these firm-years. However, for firm-years with large negative book-tax differences (book income less than taxable income), investors overestimate the persistence of the accrual component of earnings, consistent with prior research (e.g., Sloan 1996). Finally, analyst forecast data provide evidence consistent with analysts utilizing the information in the book-tax differences in a manner similar to investors: forecast errors for firm-years that have large positive book-tax differences are less optimistic.

Keywords: book-tax differences, earnings persistence, accruals, earnings expectations

JEL Classification: M41, M43, G29

Suggested Citation

Hanlon, Michelle, The Persistence and Pricing of Earnings, Accruals, and Cash Flows When Firms Have Large Book-Tax Differences (December 2002). Available at SSRN: https://ssrn.com/abstract=379140 or http://dx.doi.org/10.2139/ssrn.379140

Michelle Hanlon (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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