Book-Tax Conformity and the Information Content of Earnings

39 Pages Posted: 15 Feb 2006

See all articles by Michelle Hanlon

Michelle Hanlon

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

Edward L. Maydew

University of North Carolina at Chapel Hill

Terry J. Shevlin

University of California-Irvine

Date Written: January 31, 2006

Abstract

We examine whether the information content of earnings is inversely related to the degree of conformity between financial accounting income and taxable income. Our inquiry exploits a natural experiment first examined by Guenther et al. (1997) in which a set of U.S. firms were forced to increase their book-tax conformity as a result of a change in the tax law. We find evidence consistent with the increase in book-tax conformity reducing the usefulness of financial accounting earnings. The information content of earnings as measured by the long-window earnings response coefficients and the R-squared from a regression of returns on earnings decreases for this set of firms after the tax law required greater book-tax conformity. We find that the declines are significantly larger than the changes in the same measures for an industry-matched sample of firms not required to increase conformity. These results add to the academic literature on the interaction of taxes and financial reporting as well as to the policy debate about whether the U.S. should conform the tax law to GAAP, a debate that has recently intensified.

Keywords: book-tax conformity, information content

JEL Classification: H20, H25, M41

Suggested Citation

Hanlon, Michelle and Maydew, Edward L. and Shevlin, Terry J., Book-Tax Conformity and the Information Content of Earnings (January 31, 2006). Ross School of Business Paper No. 1029. Available at SSRN: https://ssrn.com/abstract=881561 or http://dx.doi.org/10.2139/ssrn.881561

Michelle Hanlon (Contact Author)

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

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

Edward L. Maydew

University of North Carolina at Chapel Hill ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-843-9356 (Phone)

HOME PAGE: http://www.kenan-flagler.unc.edu/faculty/directory/accounting/edward-maydew

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

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