Evidence on the Possible Information Loss of Conforming Book Income and Taxable Income

57 Pages Posted: 12 Apr 2005  

Michelle Hanlon

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

Stacie Kelley Laplante

University of Wisconsin - Madison

Terry J. Shevlin

University of California-Irvine

Date Written: January 18, 2005

Abstract

Recent corporate accounting reporting scandals and aggressive corporate tax shelters have led for calls for regulatory reform. One such call is to conform (or reduce the gap between) the calculation of book and taxable income. Proponents of conformity focus on perceived benefits while ignoring possible costs. We examine one possible cost: the loss in information content to investors if one measure is removed from the information set. We provide evidence on this possible loss by examining the relative and incremental information content over the past 20 years of book and (estimated) taxable income for a large sample of firms. We find book income exhibits significantly greater relative explanatory power while both exhibit significant incremental explanatory power. Conforming the two measures at a minimum results in the loss of incremental explanatory power and if book income is conformed to the tax rules, an estimated 50% loss in the explanatory power of earnings.

Keywords: Book-tax conformity, information content, taxable income, book income

JEL Classification: G38, H25, H32, M41, M44

Suggested Citation

Hanlon, Michelle and Laplante, Stacie Kelley and Shevlin, Terry J., Evidence on the Possible Information Loss of Conforming Book Income and Taxable Income (January 18, 2005). Available at SSRN: https://ssrn.com/abstract=686402 or http://dx.doi.org/10.2139/ssrn.686402

Michelle Hanlon

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

100 Main Street
E62-668
Cambridge, MA 02142
United States
617-253-9849 (Phone)

Stacie Kelley Laplante

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706
United States
608-265-3494 (Phone)
608-265-3494 (Fax)

Terry J. Shevlin (Contact Author)

University of California-Irvine ( email )

Paul Merage School of Business
Irvine, CA 92697-3125
United States
949-824-6149 (Phone)

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