Why Are Large Book-Tax Differences Related to Earnings Persistence?

• In Event: Earnings Properties and Saliency

Abstract

We investigate why large book-tax differences (BTDs) are associated with lower persistence of pre-tax financial accounting earnings. Prior studies argue that large BTDs reflect discretionary accruals, which are known to be less persistent and may reflect earnings management. After controlling for the size of discretionary accruals, we find that (1) earnings are less persistent for firms with large discretionary accruals regardless of the size of their BTDs, and (2) large BTDs are related to persistence even after controlling for discretionary accruals. To provide more evidence on the link between large BTDs and persistence, we examine the financial statements of a small subsample with large BTDs in one year followed by large earnings decreases in the subsequent year. Our evidence suggests that large BTDs provide useful information incremental to discretionary accruals. For example, we find that large BTDs often are associated with unusual events (such as an acquisition) that are followed by large decreases in subsequent year earnings, or relate to the use of net operating loss carryforwards not identified by Compustat. As such, large BTDs may provide helpful information unrelated to discretionary accruals or earnings management.

Authors

• David A Guenther, University of Oregon

• Xuesong Hu, University of Oregon

• Brian Williams, University of Oregon