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Evidence for the Possible Information Loss of Conforming Book Income and Taxable Income

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  • Hanlon, Michelle
  • Laplante, Stacie Kelley
  • Shevlin, Terry
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    Abstract

    Recent corporate accounting reporting scandals and aggressive corporate tax shelters have led for calls for regulatory reform. One such call is to conform (or reduce the gap between) the calculation of book and taxable income. Proponents of conformity focus on perceived benefits while ignoring possible costs. We examine one possible cost: the loss in information content to investors if one measure is removed from the information set. We provide evidence for this possible loss by examining the relative and incremental information content over the past 20 years of book and (estimated) taxable income for a large sample of firms. We find that book income exhibits significantly greater relative explanatory power, while both exhibit significant incremental explanatory power. Conforming the two measures at a minimum results in the loss of incremental explanatory power and, if book income is conformed to the tax rules, a 50 percent loss in the explanatory power of earnings.

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    Bibliographic Info

    Article provided by University of Chicago Press in its journal Journal of Law and Economics.

    Volume (Year): 48 (2005)
    Issue (Month): 2 (October)
    Pages: 407-42

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    Handle: RePEc:ucp:jlawec:y:2005:v:48:i:2:p:407-42

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    Web page: http://www.journals.uchicago.edu/JLE/

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    Cited by:
    1. Tang, Tanya Y.H. & Firth, Michael, 2012. "Earnings Persistence and Stock Market Reactions to the Different Information in Book-Tax Differences: Evidence from China," The International Journal of Accounting, Elsevier, vol. 47(3), pages 369-397.
    2. John R. Graham & Lillian F. Mills, 2007. "Using Tax Return Data to Simulate Corporate Marginal Tax Rates," NBER Working Papers 13709, National Bureau of Economic Research, Inc.
    3. Graham, John R. & Raedy, Jana S. & Shackelford, Douglas A., 2012. "Research in accounting for income taxes," Journal of Accounting and Economics, Elsevier, vol. 53(1), pages 412-434.
    4. Hill, Matthew D. & Kubick, Thomas R. & Brandon Lockhart, G. & Wan, Huishan, 2013. "The effectiveness and valuation of political tax minimization," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2836-2849.
    5. Karampinis, Nikolaos I. & Hevas, Dimosthenis L., 2013. "Effects of IFRS Adoption on Tax-induced Incentives for Financial Earnings Management: Evidence from Greece," The International Journal of Accounting, Elsevier, vol. 48(2), pages 218-247.
    6. Kager, Rebekka & Niemann, Rainer, 2011. "Reconstruction of tax balance sheets based on IFRS information: A case study of listed companies within Austria, Germany, and the Netherlands," arqus Discussion Papers in Quantitative Tax Research 120, arqus - Arbeitskreis Quantitative Steuerlehre.
    7. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    8. Laszlo Goerke, 2008. "Tax Overpayments, Tax Evasion, and Book-Tax Differences," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(4), pages 643-671, 08.
    9. Hanlon, Michelle & Heitzman, Shane, 2010. "A review of tax research," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 127-178, December.
    10. Hanlon, Michelle & Maydew, Edward L. & Shevlin, Terry, 2008. "An unintended consequence of book-tax conformity: A loss of earnings informativeness," Journal of Accounting and Economics, Elsevier, vol. 46(2-3), pages 294-311, December.
    11. Goncharov, Igor & Werner, Joerg R. & Zimmermann, Jochen, 2009. "Legislative demands and economic realities: Company and group accounts compared," The International Journal of Accounting, Elsevier, vol. 44(4), pages 334-362, December.
    12. Atwood, T.J. & Drake, Michael S. & Myers, Linda A., 2010. "Book-tax conformity, earnings persistence and the association between earnings and future cash flows," Journal of Accounting and Economics, Elsevier, vol. 50(1), pages 111-125, May.

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