Aggregate Tax Expense and Market Returns

• In Event: Audit Effectiveness and Market Reactions

Abstract

This study examines whether aggregate, or market-wide, tax expense surprises possess information content and predictive ability for market returns. Current literature provides that surprises in firm-level tax expense are value relevant because they are incrementally useful in predicting the firm’s earnings growth, assessing its earnings quality, and predicting its future tax expense surprises. However, several studies suggest that investors are inefficient with respect to firm-level tax expense; i.e., a firm’s tax expense surprise predicts its future returns. I examine whether these effects extend to the market level beyond macroeconomic and other aggregate financial statement-based measures shown to predict market returns. Overall, my results suggest that aggregate tax expense surprises possess information content at the aggregate level and are useful in predicting market returns. While I find a negative contemporaneous relation between aggregate tax expense surprises and market returns, which is inconsistent with the firm-level evidence, I find that aggregate tax expense surprises positively predict market returns.

Author

• Erin Emily Henry, University of Connecticut