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The Information Content of Tax Expense: A Discount Rate Explanation

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  • Erin Henry

Abstract

I investigate the information content of income tax expense using variance decomposition to separate stock returns into cash flow and discount rate news components. While prior literature has focused on linking tax expense with expected future cash flows, I argue that tax expense should also be informative about discount rates because of its ability to summarize fundamental economic performance. Consistent with my arguments, I find that tax expense surprises are correlated with both revisions in future cash flows and revisions in discount rates; however, the economic magnitude of tax expense's impact on returns is primarily through the discount rate channel. I also perform cross‐sectional tests, which reveal that the discount rate implications of tax expense are due not only to its ability to capture fundamental economic performance but also to its ability to convey information about a firm's earnings management and tax avoidance activities. Le contenu en information de la charge d'impôt : une explication fondée sur le taux d'actualisation L'auteure examine le contenu en information de la charge d'impôt sur le revenu à l'aide de la décomposition de la variance, afin de subdiviser le rendement des actions en ses éléments de révision des attentes relatives aux flux de trésorerie et de révision des taux d'actualisation. Alors que les travaux précédents portaient principalement sur le lien entre la charge d'impôt et les flux de trésorerie futurs prévus, l'auteure pose l'hypothèse que la charge d'impôt fournit également de l'information au sujet des taux d'actualisation grâce à sa propriété de synthétiser la performance économique fondamentale. Conformément à cette hypothèse, elle constate que les charges d'impôt imprévues sont en corrélation aussi bien avec les révisions de flux de trésorerie futurs qu'avec les révisions de taux d'actualisation; toutefois, l'importance économique de l'incidence de la charge d'impôt sur les rendements se manifeste principalement par le truchement des taux d'actualisation. L'auteure procède aussi à des tests transversaux qui révèlent que les taux d'actualisation que suppose la charge d'impôt sont attribuables non seulement à la capacité de la charge d'impôt de synthétiser la performance économique fondamentale, mais également à sa capacité de transmettre de l'information au sujet des activités de gestion du résultat et d'évitement fiscal d'une entreprise.

Suggested Citation

  • Erin Henry, 2018. "The Information Content of Tax Expense: A Discount Rate Explanation," Contemporary Accounting Research, John Wiley & Sons, vol. 35(4), pages 1917-1940, December.
  • Handle: RePEc:wly:coacre:v:35:y:2018:i:4:p:1917-1940
    DOI: 10.1111/1911-3846.12364
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    Cited by:

    1. Bradley Blaylock & Bradley P. Lawson & Michael A. Mayberry, 2020. "Taxable income, future profitability, and stock returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(7-8), pages 858-881, July.
    2. Paul Demeré, 2023. "Is tax return information useful to equity investors?," Review of Accounting Studies, Springer, vol. 28(3), pages 1413-1465, September.
    3. Byzalov, Dmitri & Basu, Sudipta, 2024. "The misuse of regression-based x-Scores as dependent variables," Journal of Accounting and Economics, Elsevier, vol. 77(2).
    4. Derrick W. H. Fung & David Jou & Ai Ju Shao & Jason J. H. Yeh, 2021. "The informativeness of embedded value reporting to stock price," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(4), pages 5341-5376, December.
    5. Dimos Andronoudis & Diogenis Baboukardos & Fanis Tsoligkas, 2024. "How the information content of integrated reporting flows into the stock market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 29(1), pages 1057-1078, January.
    6. Dimos Andronoudis & Diogenis Baboukardos & Fanis Tsoligkas, 2024. "How the information content of integrated reporting flows into the stock market," Post-Print hal-04389552, HAL.

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