Evidence of Differing Market Responses to Beating Targets Through Tax Expense Decreases

38 Pages Posted: 3 May 2007

See all articles by Cristi A. Gleason

Cristi A. Gleason

University of Iowa - Department of Accounting

Lillian F. Mills

University of Texas at Austin - McCombs School of Business

Date Written: April 30, 2007

Abstract

Prior research finds little substantial discount for managing earnings to beat analysts' consensus forecasts, but at the earnings announcement date a minority of firms disclose balance sheet data needed to estimate abnormal accruals. We consider whether the market reward for beating the forecast is smaller when firms use tax expense decreases, which are visible at the earnings announcement date. When firms beat analysts' forecasts by decreasing their tax expense relative to the third-quarter rate, the market discounts the reward by an economically significant amount: approximately 48 percent. We document the lower persistence of current-year tax changes for those firms that decrease tax expense to beat the target. We conclude that the market infers nonpersistent managed earnings from the visibility of the tax decrease to beat the forecast.

Keywords: earnings management, effective tax rate, earnings surprise

JEL Classification: M41, M43, G12, G29, H25

Suggested Citation

Gleason, Cristi A. and Mills, Lillian F., Evidence of Differing Market Responses to Beating Targets Through Tax Expense Decreases (April 30, 2007). Available at SSRN: https://ssrn.com/abstract=983612 or http://dx.doi.org/10.2139/ssrn.983612

Cristi A. Gleason (Contact Author)

University of Iowa - Department of Accounting ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States

Lillian F. Mills

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

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