Security Analyst and Stock Market Efficiency in Anticipating Tax-Motivated Income Shifting

Posted: 13 Nov 2005 Last revised: 26 Feb 2008

See all articles by Philip B. Shane

Philip B. Shane

College of William & Mary; Monash University; Monash University - Department of Accounting

Toby Stock

Ohio University - School of Accountancy

Abstract

In the context of the statutory tax rate reductions enacted in the Tax Reform Act of 1986, this paper investigates the degree to which capital market participants anticipate and correctly interpret temporary income effects of tax-motivated income shifting. We find evidence consistent with financial analysts' earnings forecasts failing to anticipate earnings management that shifts income from fourth quarters in higher tax rate years to immediately following first quarters of lower tax rate years. The evidence suggests that this failure is not the result of a decision to ignore the income shifting, but rather an inability to recognize temporary components of reported earnings. We also find evidence that market prices do not fully reflect the temporary income effects of tax-motivated income shifting, and that analyst inefficiency explains about half of the market inefficiency. We interpret these inefficiencies as potentially important costs of tax planning that could limit the ability of public firm managers to implement otherwise optimal tax strategies.

Keywords: Analysts' forecasts, analyst and market efficiency, taxes, earnings management

JEL Classification: M41, M43, H25, G14, G29, D82

Suggested Citation

Shane, Philip B. and Stock, Toby, Security Analyst and Stock Market Efficiency in Anticipating Tax-Motivated Income Shifting. Accounting Review, January 2006. Available at SSRN: https://ssrn.com/abstract=843664

Philip B. Shane

College of William & Mary ( email )

P.O. Box 8795
Williamsburg, VA 23185
United States

Monash University ( email )

23 Innovation Walk
Wellington Road
Clayton, Victoria 3800
Australia

Monash University - Department of Accounting ( email )

H3.43, Building H, Level 3
Monash University Caulfiled
Melbourne, VIC 3145
Australia

Toby Stock (Contact Author)

Ohio University - School of Accountancy ( email )

College of Business Administration
526 Copeland Hall
Athens, OH 45701
United States
740-593-2016 (Phone)
740-593-2412 (Fax)

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