The Presistance, Forecasting, and Valuation Implications of

The Tax Change Component of Earnings

Andrew P. Schmidt

Oleh :

Intan Oviantari

Introduction• The tax change component of earnings is likely to have

implications for earnings persistence for a number of reasons :

1. the small changes in ETR can lead to substantial changes in earnings

2. corporate manager placing greater emphasis on ETRs as in house tax departments are increasingly viewed as profit centers

3. Recent academic literature has identified ETR manipulation as an earnings management tools.

Contribution

• Examines the persistence and pricing implications of book tax differences by directly examining how taxes contribute to earnings prediction, wich is consistent with the view that one task of accounting research is to discover what information in the financial statements projects future earnings (Penman 1992)

Previous Study

(Sloan 1996; Hribar 2001; Nissim & Penman 2001; Barth et al 2004)

• ignores or agregate taxes with other earnings component

Hanlon 2005 • examines the implications of information contained in temporary book tax differences (DTE) for the quality of pretax earnings

(Shevlin 2002; Hanlon et al 2005; Lev 7 Nissim 2004)

• examines the informativeness of estimated taxable income to capital markets

(hanlon 2005; Gleason & Mills; Guenther & Jones 2003; Lev & Nissim 2004)

• suggest tax related earnings information is priced by the market

Corporate Income Tax Disclosure

Research Questions and Hypotheses

Research Design

Hypotheses 1

Hypotheses 2a dan 2b

Sample Selection Procedures and Sample Profile

Descriptive Statistics

Empirical Result• Tabel 1 Panel A : TRQ1 significantly higher

than ETRt-1 and ETR. Indicates that management sets the estimates of the annual ETR too high in Q1, perhaps to create a reserve from which current earnings can be drawn, or because tax department are conservative in their initial estimates (Comprix et al. 2006)

Empirical Result• Tabel 1 Panel B : For the average firm in

the sample, approximately 60% of INTCCt reverses by year end. Consistent with panel A and quantifies the effect of tax chnages on earnings.

• Tabel 1 Panel C : present descriptive statistics for the risk and anomaly control variables.

Tabel 1

Tabel 2

The Persistence and Forecasting Implications of the Tax Change Component of Earnings

The Persistence and Forecasting Implications of the Tax Change Component of Earnings in

Interim Periods

Valuation Implication of the Tax Change Component of earnings

Conclusions

• There is a positive, significant association between the tax change component of earnings and future earnings.

• The initial tax change component is more persistence, therefore, more useful in forecasting future earnings than the revised tax change component.

• These results are consistent with H1.• Result from market tests indicate that investors underweight the

forecasting implications of the tax change component and the mispricing appears to be driven by the transitory nature of the revised tax change component

• Supplemental test confirm that the result obtained from the market test are likely a result of mispricing rather than alternative expalanation such as omitted risk factors.

Conclusions

• The result suggest that investors can gain from breaking the tax change component of earnings into an initial and revised portion

• If investor focus on the initial tax change component, they can better understand the persistence of earnings generated by ETR changes, and consequently, make better forecast of future earnings.

• Such an understanding should also decrease the mispricing of ETR related earnings.

• Investors may also benefit by focusing on the relative lack of persistence for the revised tax change component. When viewed in the context of concurrent research that find Q2, Q3, Q4 ETR revisions are used to meet or beat periodic specific benchmarks (e.g., analyst forecasts), the lower persistence of the revised tax change component is consistent with manager using the revised tax change component as an earnings management tool.

• Increased attention to this issue may mitigate such behaviour by managers.