Two Essays Using Decomposition of Tax Expense

Authors

Shujia MeiFollow

Document Type

Dissertation

Degree

Doctor of Philosophy (PhD)

Major/Program

Business Administration

First Advisor's Name

Abhijit Barua

First Advisor's Committee Title

Committee Chair

Second Advisor's Name

Kelly Huang

Second Advisor's Committee Title

Committee Member

Third Advisor's Name

Jonathan Milian

Third Advisor's Committee Title

Committee Member

Fourth Advisor's Name

Qiang Kang

Fourth Advisor's Committee Title

Committee Member

Keywords

Tax Expense, Stock Return, Valuation, Analysts, Forecasts, ETRs, taxes

Date of Defense

6-20-2023

Abstract

Tax expense is typically presented as a percentage (“effective tax rate”) of pre-tax earnings. In this dissertation research, I use a decomposition approach that views tax expense as a function of both pre-tax earnings and tax rate. I examine the following two topics: (i) the valuation of tax expense, and (2) the accuracy of analysts’ tax forecasts compared with that of their pre-tax earnings forecasts.

In the first essay, I examine how the association between the two decomposed components of tax expense surprises and stock returns explains the two competing roles of tax expense documented in Thomas and Zhang (2014): the proxy-for-profitability role and the matching role. To disentangle these two roles, I decompose tax expense surprise into two components: the pre-tax earnings surprise component (“PTE component”) and the effective tax rate surprise component (“ETR component”). I then examine how these two decomposed components are associated with contemporaneous stock returns. The findings show that the PTE component mainly serves the proxy-for-profitability role of tax expense, while the ETR component is the main channel for the matching role. The manifestation of the proxy-for-profitability and matching roles through the respective components is conditional on several factors, such as (a) the strength of the relationship between nontax variables (i.e., pre-tax earnings) and stock returns, (b) the significance of permanent book to tax differences, and (c) the level of tax avoidance and tax risks.

In the second essay, I examine how the accuracy of analysts’ tax forecasts compares with that of their pre-tax earnings forecasts. The findings suggest that analysts, on average, face more challenges and uncertainty when forecasting taxes. In addition, I find that the relative accuracy of analysts’ tax forecasts vs. their pre-tax earnings forecasts decreases with the increase in tax and firm complexity. The relative accuracy decreases for larger firms, potentially due to the availability of high-quality public information hindering analysts’ efforts in acquiring private information that is the primary source for analysts’ forecasts of taxes. However, with the increase in analysts following that enriches a firm’s information environment, the relative accuracy of analysts’ tax forecasts improves.

Identifier

FIDC011172

Recommended Citation

Mei, Shujia, "Two Essays Using Decomposition of Tax Expense" (2023). FIU Electronic Theses and Dissertations. 5395.
https://digitalcommons.fiu.edu/etd/5395