Analysts’ pre-tax income forecasts and the tax expense anomaly

Analysts’ pre-tax income forecasts and the tax expense anomaly This paper examines whether analysts’ pre-tax income forecasts mitigate the tax expense anomaly documented by Thomas and Zhang (J Account Res 49:791–821, 2011). They find that seasonal changes in quarterly income tax expense are positively related to future returns after controlling for the earnings surprise and conclude that investors underreact to value-relevant information in tax expense. When analysts issue both earnings and pre-tax income forecasts, they implicitly provide a forecast of income tax expense. We posit that this implicit forecast helps investors recognize the persistence of current tax expense surprise for future earnings. Accordingly, we expect that mispricing of tax expense will be less severe for firms with earnings and pre-tax income forecasts. As expected, we find that the presence of pre-tax income forecasts significantly weakens the positive relation between tax expense surprise and future returns, consistent with analysts’ implicit forecasts of tax expense mitigating the tax expense anomaly. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Analysts’ pre-tax income forecasts and the tax expense anomaly

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Publisher
Springer Journals
Copyright
Copyright © 2016 by Springer Science+Business Media New York
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-016-9349-z
Publisher site
See Article on Publisher Site

Abstract

This paper examines whether analysts’ pre-tax income forecasts mitigate the tax expense anomaly documented by Thomas and Zhang (J Account Res 49:791–821, 2011). They find that seasonal changes in quarterly income tax expense are positively related to future returns after controlling for the earnings surprise and conclude that investors underreact to value-relevant information in tax expense. When analysts issue both earnings and pre-tax income forecasts, they implicitly provide a forecast of income tax expense. We posit that this implicit forecast helps investors recognize the persistence of current tax expense surprise for future earnings. Accordingly, we expect that mispricing of tax expense will be less severe for firms with earnings and pre-tax income forecasts. As expected, we find that the presence of pre-tax income forecasts significantly weakens the positive relation between tax expense surprise and future returns, consistent with analysts’ implicit forecasts of tax expense mitigating the tax expense anomaly.

Journal

Review of Accounting StudiesSpringer Journals

Published: Feb 3, 2016

References

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