Evidence of Differing Market Responses to Meeting or Beating Targets Through Tax Expense Management
48 Pages Posted: 2 Apr 2004
Date Written: March 10, 2005
Does using earnings management to meet or beat analysts' forecasts decrease the market reward to achieving this target? We use changes in effective tax rates from the third to the fourth quarter to estimate managed earnings, following and extending Dhaliwal, Gleason and Mills (2004). We demonstrate that the market discounts the reward to meeting or beating forecasts by an economically significant amount when the company achieves the target through earnings management, using a decrease in tax expense. Our findings are consistent with firms using earnings management to avoid the market punishment of missing the forecast, but failing to capture the full market reward for meeting the target without management. Our results are robust to including an estimate of abnormal accruals and suggest that identifying firms that manage tax expense contributes incrementally in understanding the market response to meeting or beating earnings.
Keywords: earnings management, effective tax rate, earnings surprise
JEL Classification: M41, H25
Suggested Citation: Suggested Citation