Evidence of Differing Market Responses to Beating Targets Through Tax Expense Decreases
38 Pages Posted: 3 May 2007
Date Written: April 30, 2007
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: Suggested Citation