Is there Information Content in the Tax Footnote?
Jana S. Raedy
University of North Carolina
Jeri Seidman
University of Texas at Austin
Douglas A. Shackelford
University of North Carolina and NBER
February 2011
ABSTRACT
Prior studies show that aggregated book-tax differences have information content that is
incremental to pre-tax book income. We test whether the detailed book-tax difference disclosures
from statements of deferred tax position and rate reconciliations have information content that is
incremental to the aggregate book-tax difference. Using hand-collected data from the Fortune
250 from 1993 to 2007, we find little evidence that the equity markets price different book-tax
differences differently, consistent with no incremental information content. Further work is
needed to explain why the sum of the book-tax differences matter to investors, but the parts do
not.
We appreciate the insights and encouragement of Jim Poterba; comments from Michelle Hanlon,
Justin Hopkins, Ed Maydew, Dan Taylor, and Jake Thornock; workshop participants at the 2010
Oxford University Centre for Business Taxation Annual Symposium, the University of North
Carolina, and the University of Pennsylvania; and the financial support of the UNC Tax Center.
We are indebted to numerous students at the Massachusetts Institute of Technology, the
University of North Carolina, and the University of Texas for their research assistance in the
collection and organization of the primary data used in this study.
1. Introduction
Firms disclose detailed information in the footnotes of their financial statements. This
study evaluates the information content of one of the most complicated footnotes, the tax
footnote. In particular, we attempt to determine whether the equity markets find the specific
differences between book income and taxable income (book-tax differences or BTDs) detailed in
the tax footnote informative.
Prior studies (e.g., Hanlon et al., 2005, hereafter HLS) report that taxable income
(estimated from the financial statements) has information content that is incremental to pretax
book income. Since BTDs are the differences between book income and taxable income, the
HLS results can be interpreted as evidence that the market prices aggregated BTDs. The
incremental contribution of this study is that we assess whether the disaggregated BTDs found in
the tax footnote matter to the capital markets. In other words, do investors price the specific
BTDs or just the sum of all BTDs? By evaluating the association between share prices and 41
specific BTDs, conditional on aggregated BTDs, we are able to determine whether the
association between BTDs and share prices varies across accounts.
To date, the lack of computer-readable information about the tax footnote in the financial
statements (the source of detailed BTD information) has prevented scholars from disaggregating
the BTDs and identifying the ones that are incrementally informative. Consequently, it is
difficult, if not impossible, to know whether investors distinguish among the specific disclosures
in the tax footnote. We overcome this limitation by hand collecting data from the statements of
deferred tax positions and the rate reconciliations in the tax footnotes of the Fortune 250 from
1993 to 2007. These data enable us to test the association between current stock returns and
individual BTDs.
BTDs have been documented to matter in various settings. Extant studies find
associations between aggregated BTDs and current and future returns, earnings persistence,
earnings growth, earnings-to-price ratios, big baths, credit ratings, borrowing costs, restatements,
share turnover, stock return variance, analyst forecasts, tax shelters, and IRS audits, among other
things.1 The fact that BTDs are so well associated is not surprising because, as the bridge
between the financial statements and the tax returns, BTDs involve almost every element of the
firm. Typically accounting research has used the financial statements to estimate a single
aggregated BTD measure that draws from every account for which book and tax accounting
differ plus tax credits and foreign and state rate differentials. Therefore, to say that total book-tax
differences are informative is akin to saying that the financial statements and the tax returns
communicate information about a firm.
This paper tests whether investors analyze the specific items in the tax footnote and price
dissimilar BTDs differently. If they ignore the disaggregated BTDs or find them uninformative,
then we expect all BTDs to have the same information content. If they evaluate the BTDs related
to depreciation differently from those related to the allowance for doubtful accounts or the
valuation allowance or the foreign tax rate differential, etc., then we expect the association
between returns and these different BTDs to vary.
1
For a sampling of papers focusing on book-tax differences and accrual quality, see Mills and Newberry (2001),
Phillips et al. (2003), Lev and Nissim (2004), Hanlon (2005), Badertscher et al. (2009), Blaylock et al. (2010),
among many others. For a sampling linking BTDs and tax avoidance, see Mills (1998), Desai (2003), Desai and
Dharmapala (2006, 2009), Wilson (2009), Lisowsky (2009), and Chen et al. (2010), among many others. For
examples of papers focusing on BTDs and both accrual quality and tax avoidance, see Frank et al. (2009) and
Seidman (2010). For an example of BTDs and divergence of opinion among investors, see Comprix et al. (2010).
For reviews of the entire literature, see Hanlon and Heitzman (2010) and Graham et al. (2010).
2
This study begins with the HLS finding that aggregated BTDs matter to equity investors.
Motivated by whether the capital markets would suffer a loss of information if book-tax
conformity were mandated, HLS regress long-window contemporaneous returns on pretax book
income and their estimate of taxable income (current income tax expense, grossed-up by the
statutory tax rate, adjusted for the change in net operating loss carryforwards). They do not
predict the sign of the coefficient on estimated taxable income. Instead, they simply test whether
the coefficient is significantly different from zero, contending that a significant coefficient in
either direction will be consistent with estimated taxable income being incrementally
informative.2 They find a positive coefficient and argue that conforming book and tax
accounting, as has been suggested in some policy circles, would result in a loss of information
for the capital markets.3
This paper is not interested in the book-tax conformity debate. Rather, we build on the
HLS finding about aggregated BTDs to understand the pricing of disaggregated BTDs. The
variable of interest in HLS is estimated taxable income. When it is included in the regression
along with pretax book income, the coefficient that loads on estimated taxable income is
capturing the mean difference between estimated taxable income and pretax book income (i.e.,
the incremental impact of estimated taxable income, conditional on pretax book income). An
alternative specification of the model that would reach the same inferences (about information
2
As an aside, suppose some specific book-tax differences are incrementally informative—some positively so and
some negatively so. If the positive and negative effects largely offset in the HLS setting, then the coefficient on
estimated taxable income in the HLS model might not significant. If that had happened, HLS would have
erroneously inferred that the market would suffer no loss of information under book-tax conformity. Thus, their test
of the effect of book-tax conformity on market information is incomplete. As constructed, they could only find that
estimated tax income is informative when positive effects dominate negative effects or vice versa.
3
Besides HLS, key papers exploring the book-tax conformity debate include Guenther et al. (1997), Ali and Hwang
(2000), Young and Guenther (2003), Desai (2005), Hanlon and Shevlin (2005), McClelland and Mills (2007),
Hanlon et al. (2008), Hanlon and Maydew (2009), and Atwood et al. (2010). For a sampling of the Congressional
testimony regarding book-tax conformity, see Brown (2007), Desai (2007, 2006) and Shackelford (2006). Graham et
al. (2010) review this literature.
3
that is incremental to pretax book income) would retain pretax book income as an explanatory
variable but replace estimated taxable income with the difference between pretax book income
and estimated taxable income. That difference between pretax book income and estimated
taxable income is the aggregate book-tax differences. In other words, while HLS argue that
estimated taxable income is informative, they could have just as easily argued that book-tax
differences are informative.
Building on this insight, we disaggregate total book-tax differences into the specific
book-tax differences detailed in the financial statements and add this collection of BTDs (both
fully disaggregated and aggregated into different groupings) to the HLS model. Aggregated
BTDs reflect the mean effect of all BTDs. If the market understands the information in BTDs
and thus prices different BTDs differently, a positive coefficient should load on some of the
book-tax differences, a negative coefficient should load on other book-tax differences, and
perhaps nothing will load on another set of book-tax differences.
When we include the 41 individual book-tax differences in the regression model, we find
only three individual BTDs that are associated with current stock returns. The significant BTDs
are two temporary differences, the valuation allowance and certain costs associated with mergers
and acquisitions, and one permanent different, adjustments to tax reserves disclosed in the rate
reconciliation. Since we would expect a few significant coefficients by chance, the findings are
consistent with investors largely ignoring the detailed book-tax differences in the tax footnote.
This does not imply that these disclosures are useless. Other users of the financial statements
may find these disclosures informative (e.g., creditors or the taxing authorities). However, we
detect little, if any, evidence that share prices are affected by the details in the statements of
deferred tax positions or the rate reconciliation. These findings are surprising because prior
4
studies show that aggregated BTDs are associated with various different characteristics of
earnings. Further work is needed to explain why investors do not find individual BTDs
informative, but they do find those same BTDs informative when they are aggregated. In short,
why is the whole greater than the sum of its parts?
The paper proceeds as follows: Section 2 provides background regarding what types of
information may be gleaned from these disclosures. Section 3 details the empirical design.
Section 4 reports the empirical findings. Closing remarks follow.
2. Background
As mentioned above, HLS show that aggregated book-tax differences have information
content. The purpose of this paper is to attempt to discriminate between those specific BTDs that
are more informative and those that are less informative. Unfortunately, theory is insufficiently
rich for us to advance detailed hypotheses about which BTDs matter, how much they matter, and
why they matter. For example, among other things, a decrease in the valuation allowance might
signal that the firm has become more optimistic about its potential for realizing deferred tax
assets either because its economic outlook has brightened or the tax law governing carryover
periods have been lengthened. Alternatively, the firm could reduce their valuation allowance to
manage earnings upwards. In other words, a change in the valuation allowance may signal a
change in the firm’s economic performance, a change in the tax law, or earnings management
behavior. Multiple stories can be told for many BTDs. Thus, we are agnostic on the reasons why
the market might find specific BTDs informative.
Therefore, it is tempting to jump directly to the empirical tests and ignore any discussion
of the possible sources of information among the specific BTDs. However, in the spirit of
5
providing some structure for evaluating our findings, we divide the disaggregated BTDs into
three groups based on whether they provide 1) information regarding accrual quality, 2)
information regarding tax avoidance or 3) little useful information. Our reasoning is as follows:
as the connection between book income and taxable income, book-tax differences should first
and foremost provide investors with incremental information about the quality of the book
numbers (by providing a comparison of the book figures with an alternative measurement
system, the tax law) and/or provide incremental information (beyond the income tax expense and
cash taxes paid) about the firm’s tax liabilities. We emphasize “incremental” information
because we assume that other disclosures in the financial statements, such as net income, are
more useful than BTDs at providing certain information, such as information about the firm’s
economic performance. Finally, we do not view these classifications as authoritative and
recognize that alternative interpretations are possible.
With that disclaimer, we discuss each group in turn, starting with possible information
about accrual quality. Prior studies have concluded that market participants use the aggregated
BTDs to assess the accrual quality of pretax book income (e.g., Hanlon, 2005 and Blaylock et al.,
2010).4 Thus, disaggregated BTDs that reflect accrual quality should significantly affect returns
even controlling for aggregated BTDs. Non-conforming accounts that potentially give rise to
accrual quality BTDs are those where sufficient financial accounting discretion exists that firms
could manipulate their accruals to advantageously manage their earnings. An example of a
deferred tax position potentially related to accrual quality is unearned revenue. When cash
prepayments are received, they are taxed immediately but recorded as a liability for book
purposes. Since managers have some leeway in the timing of the revenue recognition for book
4
We use the term, “accrual quality” in the spirit of Dechow et al. (2009, p.1), who state that “Higher quality
earnings more faithfully represent the features of the firm’s fundamental earnings process that are relevant to a
specific decision made by a specific decision-maker.”
6
purposes, they potentially can use this account to achieve financial accounting goals without
affecting their tax liability. Investors may use unexpected changes in these types of BTDs to
assess a firm’s accrual quality. 5 For example, unexpected decreases in the deferred tax asset for
unearned revenue will arise if firms are more aggressively recognizing revenue in the current
year than they did in the prior year. Assuming book income exceeds taxable income and holding
book income constant for simplicity sake, a deferred tax liability suggests that taxable income
decreased, widening the book-tax gap. Conversely, a deferred tax asset suggests that taxable
income increased, relative to book income, narrowing the book-tax gap.6 In other words, if firms
choose to use unearned revenues or similar accounts to manage book income, their manipulation
should leave footprints in their deferred tax accounts in a predictable manner.7
One reason that we might fail to detect the anticipated association between stock returns
and BTDs for accrual quality assessment is that earnings management can take many forms.
Under some circumstances (e.g., big baths and the creation of cookie jar reserves), increases
(decreases) in deferred tax assets (liabilities) would be consistent with earnings manipulation.
The second group of differences concerns disclosures related to tax avoidance.
Disclosures in both the statement of deferred tax positions (e.g., NOL carryforwards) and the rate
reconciliation (e.g., tax-exempt interest) potentially provides investors with information about
current and future tax liabilities. For example, information regarding the usage or creation of tax
credits or the amount of tax exempt income may help investors estimate future tax payments.
5
Our benchmark for the expected change in deferred tax position is the prior year change. Because recurring
temporary differences are not generally reversing in growth firms, this assumption seems reasonable.
6
Consistent with this notion, we sign deferred tax assets as negative and deferred tax liabilities as positive.
Unexpected decreases (unexpected increases) in deferred tax assets (deferred tax liabilities) will be positive,
consistent with these changes widening the book-tax gap.
7
Note that this example is consistent with Hanlon’s (2005) finding that positive temporary BTDs (which would
arise from decreasing deferred tax assets or increasing deferred tax liabilities) are associated with lower earnings
persistence.
7
Unless disclosed in the Management Discussion and Analysis section of the annual report, this
information is generally not found elsewhere in the financial statements.
That said, we may fail to detect the anticipated association between stock returns and
BTDs associated with tax avoidance because investors may view some forms of tax avoidance
negatively (Hanlon and Slemrod, 2009). For example, involvement in a tax fraud or some forms
of corporate tax shelters, even if they reduce current taxes, might bring reputational damage.
Another reason is that an increase in an activity that minimizes taxes may suggest poor current
performance. For example, increases in tax-exempt interest reduce taxes but may indicate an
increase in tax-exempt investments, suggesting that the firm has few taxable positive NPV
investment options available.
Our final set of BTDs relates to deferred tax positions and reconciling items with limited
descriptions. “Other” is a common label for both temporary and permanent differences. One
reason that firms report certain BTDs under the “other” label is that, although all significant
deferred tax elements and reconciling items must be disclosed, SEC Reg S-X Rule 4-08(h)
defines significant as 5% of the amount computed by multiplying the income before tax by the
applicable statutory federal tax rate. Another reason why firms might report this way is that
sensitive information may be buried in “Other.” Whatever the reason, such limited descriptors
would seem insufficient to convey information.
3. Empirical Design
3.1. Regression Equation
In their attempt to assess whether book-tax conformity would reduce the information
provided to the capital markets, HLS estimate the following equation for each year from 1983 to
2001.
8
Ri = β 0 + β1 ∆PTBI i + β 2 ∆TI i + ε i ,
(1)
where Ri denotes the market-adjusted return for firm i and is defined as the compound (with
dividend) return less the compound return on the value-weighted market portfolio. Returns are
calculated over a 16-month period, starting at the beginning of fiscal year t and ending four
months after the end of the fiscal year t. ∆PTBI i is the change in pretax book income
(Compustat item PI) less minority interest (MII). ∆TIi is the current income tax expense,
grossed-up by the statutory tax rate and adjusted for the change in net operating loss
carryforwards. Both ∆PTBI i and ∆TIi are scaled by the market value of equity at the beginning
of the year. HLS finds that the coefficient on ∆TIi is positive, which they interpret as evidence
that the market finds their estimate of taxable income (derived solely from the financial
statements) to have information content, even after controlling for pre-tax book income.
The HLS results can be interpreted as measuring the mean price for all BTDs aggregated
together. We extend the HLS model to determine the average price for each individual BTD. If
investors impound the information in the tax footnote into share prices, we expect the price of
some BTDs to exceed the mean and the price of others to be less than the mean. We begin by
recognizing that β2 from estimating equation (1) would identical to β 2 from estimating equation
(2):
Ri = β 0 + β1 ∆PTBI i + β 2 (∆TI i − ∆PTBI i ) + ε i
In other words, HLS could have conducted their tests using either equation (1) or equation (2).
Consequently, although HLS report that their estimate of changes in taxable income has
information content, they could just have as easily reported that ( ∆TI − ∆PTBI ), which is the
difference between changes in taxable income and changes in pre-tax book income, has
9
(2)
information content. We can restate ∆TI i − ∆PTBI i as (TI t − PTBI t ) − (TI t −1 − PTBI t −1 ) . Since the
convention is to define book-tax differences as book income less taxable income (rather than
taxable income less book income, as in equation (2)), we take the product of -1 and
(TI t − PTBI t ) − (TI t −1 − PTBI t −1 ) to get ( PTBI i − TI i ) − ( PTBI i −1 − TI i −1 ) or ∆( PTBI − TI )i which
we then substitute for ∆TI − ∆PTBI in equation (2) to yield:
Ri = β 0 + β1 ∆PTBI i + β 2 [∆( PTBI − TI ) i ] + ε i
(3)
In our tests we replace the aggregated BTDs ( ∆( PTBI − TI )i ) with our specific handcollected book-tax differences ( ∆BTDi ). However, there is measurement error in both the
estimated aggregate differences in HLS, ( ∆( PTBI − TI )i ), and in the sum of our specific handcollected difference, ( Σ∆BTDi ).8 Therefore, we include the difference between these two
measures [∆( PTBI − TI )i − Σ∆BTDi ] in the regression model.9 This leads to equation (4):
Ri = β 0 + β1 ∆PTBI i + β 2 [∆ ( PTBI − TI ) i − Σ∆BTDi ] + Σβ 3 j ∆BTDij + ε i
(4)
Rearranging terms (and including year and industry indicator variables), the primary model that
we estimate in this paper is:
Rit = γ 0 + γ 1 ∆PTBI it + γ 2 ∆TI it + Σγ 3 j ∆BTDitj + Σγ 4 t YEARt + Σγ 5 k INDitk + ε it
(5)
We will interpret the ∆BTDit coefficients as providing evidence about the information
content of each book-tax difference, incremental to the information content of the average BTD
from HLS. In contrast to HLS who test each year separately, our sample size does not permit us
8
Measurement error in the aggregate book-tax differences estimated using machine-readable data includes items
that affect tax expense but not taxable income, such as the use of credits or state tax expense. Measurement error in
the hand-collected book-tax differences includes the effect of mergers and acquisitions on the calculation of
changes. Both methods are subject to measurement error from such sources as employee stock options and tax
cushion. See Hanlon (2003) for additional discussion.
9
Including the difference between the aggregated BTDs and the sum of the disaggregated BTDs enables us to rule
out the possibility that the differences in their measurement errors explain why aggregated BTDs have information
content but disaggregated BTDs do not.
10
to estimate each year separately. Thus, we include an indicator variable ( YEARt ) for each year.
Because we find that BTDs vary substantially across industries, consistent with GAAP and tax
law differing significantly across industries, we include categorical variables ( INDi ) for each of
the fourteen industries used in Barth et al. (1998). That said, we find that adding year and
industry indicator variables has no impact on our inferences. Lastly, the non-categorical variables
are scaled by the market value of equity at the beginning of the year.
3.2. Sample Selection
As mentioned above, details about specific BTDs are generally unavailable in computerreadable form. Thus, to conduct tests about individual BTDs, we collect data from the tax
footnote in 10-K filings for Fortune 250 firms for the fiscal years 1993-2007.10 More
specifically, we collect data for the entire sample period for any firm in the Fortune 250 in any
year between 1995 and 2004.11 Four hundred and eight firms appear in the Fortune 250 at least
once between 1995 and 2004. We do not collect data on 22 firms.12 Because IPOs, mergers,
bankruptcy, and going-private transactions eliminate some firms or disclosures, not all firms
remain in the sample for all years. To further supplement the sample, we use tax footnote data
from Poterba et al. (2010) for firms involved in corporate control transactions with members of
10
By beginning the sample with fiscal year 1993, the first year when all firms’ financial statements were prepared in
accordance with SFAS No. 109, we avoid commingling tax information in the financial statements governed by
SFAS No. 109 with tax information in the financial statements governed by its predecessors.
11
Before 1995, Fortune ranked only manufacturing firms. To avoid including firms that are only in the Fortune 250
because non-manufacturing firms were excluded before 1995, we formed our sample using the Fortune rankings
from 1995 to 2004.
12
The 22 excluded firms are nine private companies that do not file publicly-available 10-Ks: AXA Financial,
Borden Chemical, Levi Strauss, Premcor, State Farm Insurance, Supermarket General Holdings, TIAA-CREF and
the two predecessor firms of TIAA-CREF; two government-sponsored enterprises: Fannie Mae and Freddie Mac;
two co-operatives: CHS and Farmland Industries; one publicly traded LP: Plains All American Pipeline; seven
mutual companies: Guardian Life of America, Liberty Mutual Insurance Group, Massachusetts Mutual Life
Insurance, Nationwide, New York Life Insurance, Northwestern Mutual, and USAA; and one firm for whom we
were unable to locate 10-K filings: R. H. Donnelley.
11
the Fortune 50. Firms acquired by a Fortune 50 firm were collected before the merger and firms
divested by a Fortune 50 firm were collected after the spin-off. This process yields an additional
1,089 observations (260 firms), providing us with a total sample of hand-collected data for 5,688
firm-year observations over 646 firms.
We match each firm-year observation with Compustat using both firm name and year,
and validate the match using total assets and net income. Twenty firm-years are dropped because
they do not have a valid match with Compustat.13 We lose another 669 firm-years because they
are missing information needed to compute the HLS estimate of taxable income. Because a key
measure in the study, the year-to-year change in temporary differences (i.e., the change in BTDs
from year t-1 to year t compared with the change in BTDs from year t-2 to year t-1) requires
three consecutive years of data for each firm, 701 firm-years are lost. We drop another 147
observations because at least one month of returns is missing from the required 16-month return
beginning at the start of the fiscal year. Finally, we delete 13 firm-years because of a change in
fiscal year-end and another 230 firm-years because they did not have a sufficiently large
industry-group in the Compustat universe to calculate the industry-year rank of their cash ETR (a
long-run measure of cash taxes paid over pre-tax income), which we use in secondary tests.
Because items after Income Before Taxes (such as discontinued operations, extraordinary items,
and the effect of a change in accounting principle) and additions to Other Comprehensive
Income can affect deferred tax assets and liabilities (which we use to derive measures of
temporary differences) without affecting pre-tax income, these items may add significant noise
13
We collected tax information from the first 10-K or annual report filing for each fiscal year. Restatements can
cause differences between the total assets and net income entries in the 10-K and those reported in Compustat. We
hand-checked the observations where neither total assets nor net income corresponded to our hand-collected total
assets and net income numbers. Most differences were small and the observation was retained in our dataset. We
dropped 20 firm-years, 18 for which Compustat did not have any data for that year, one where a partial year or
merger caused a significant mismatch between the data we collected and that reported by Compustat, and one with
major differences for undeterminable reasons.
12
to our measures of book-tax differences. Therefore, we remove the 183 firm-years with more
than 10% of discontinued operations, extraordinary items, change in OCI, or the effect of a
change in accounting principle, relative to market value of equity at the beginning of the year.
The final sample has 3,725 firm-years.
3.3. Book-Tax Difference Variables
3.3.1. Classifications
GAAP requires firms to disclose a schedule of deferred tax positions that provides
information about deferred tax assets and liabilities and a rate reconciliation that reconciles
reported income tax expense with the amount that would result from applying the domestic
federal statutory rate to global pretax income.14 From these disclosures, we hand collect the
specific BTDs from our sample of Fortune 250 companies and then dichotomize them into
temporary and permanent differences.
Most companies follow a stable reporting policy from year-to-year. For our sample of
Fortune 250 firms, the mean (median) change from year-to-year in the number of deferred tax
positions disclosed is 0.8 (zero) with 52% of the firm-years reporting no change in the number of
disclosed deferred tax positions. The mean (median) change from year-to-year in the number of
line items presented in the rate reconciliation is 0.7 (one) with 49% of the firm-years reporting
no change in the number of items disclosed in the rate reconciliation.
Companies list more accounts and more dollars on their statements of deferred tax
positions than they do on their rate reconciliations. However, both disclosures are substantial.
14
All significant reconciling items must be disclosed. As mentioned above, SEC Reg S-X Rule 4-08(h) defines
significant as 5% of the amount computed by multiplying the income before tax by the applicable statutory federal
tax rate.
13
The number of accounts listed on the statement of deferred tax positions for our sample of
Fortune 250 firms ranges from two to 28 with a mean (median) of ten (nine) and a standard
deviation of three. The total income dollars of deferred tax positions in absolute value ranges
from $877,000 to $85 billion with a mean (median) of $2601 ($1001) million and a standard
deviation of $4,957 million. The number of reconciling items ranges from zero to 17 with a mean
and median of four and a standard deviation of two. The total income dollars of reconciling items
in absolute value ranges from zero to $30 billion with a mean (median) of $678 ($230) million
and a standard deviation of $1585 million.15
Although the reporting policy is stable within firms, the wide variation across companies
in the level of detail and the terms used to describe their accounts potentially introduces a
problem in this study.16 While variation in reporting practices is a problem that many accounting
studies face, it is important to recognize that differences in characterization and aggregation
across firms potentially reduce the power of our tests because similar transactions are reported
differently and different transactions are reported similarly.
To mitigate the problems associated with divergent classifications across firms, we
attempt to provide some standardization by grouping similar items together. We form 22
categories from the statement of deferred tax positions and 19 categories from the rate
reconciliation. The Appendix provides details about representative items in each category.
15
In their call for a descriptive study of common permanent differences, which this paper attempts to provide at
least in part, Hanlon and Heitzman (2010) assert that “…permanent differences are rare relative to the frequency of
temporary differences. Based on our comparison of the statements of deferred tax positions and rate reconciliations,
“rare” appears a bit strong, but temporary differences are larger and appear more frequently than do permanent
differences.
16
The divergence in tax footnote disclosure policy across firms is an intriguing question in its own right. Though
beyond the scope of this study, we look forward to future work that attempts to explain why some firms provide
extensive details about their deferred tax accounts and reconciling items and other firms largely aggregate all
accounts and items.
14
3.3.2. Categories from the Statement of Deferred Tax Positions
Table 1 provides descriptive statistics for the 22 categories of temporary differences
calculated from the statements of deferred tax position. Temporary differences are calculated as
changes in net deferred tax liabilities (assets), stated in millions of dollars of income. Consistent
with BTDs being defined as book income less taxable income, temporary differences that
increase the difference between book and taxable income are coded as positive while those that
reduce this difference are coded as negative.17 The first column presents the means for the entire
investigation period. These means are difficult to interpret because temporary differences, by
definition, reverse. Thus, a near-zero mean over the entire investigation period could signify that
the temporary difference is tiny. Alternatively, the temporary difference could be large, but
reverse quickly, e.g., differences surrounding year-end, such as vacation pay. The second column
shows the percentage of all observations for which that variable is not zero. The remaining
columns present the annual mean values from 1995 to 2007.18
Not surprisingly, the most frequently disclosed category is OTHER-t, which includes all
items with such inadequate description, e.g., “other adjustments,” that we could not place that
17
Specifically, we code temporary differences that increase a deferred tax liability, e.g., tax depreciation exceeds
book depreciation, as positive values because they represent lower taxable income relative to book income,
increasing the book-tax gap. Conversely, temporary differences that decrease a deferred tax liability, e.g., book
depreciation exceeds tax depreciation are listed as negative values because they increase taxable income relative to
book income and reduce the difference between book and taxable income. On the other hand, temporary differences
that increase a deferred tax asset, e.g., recording benefit deductions accelerated relative to expenses, are coded as
negative values because they result in higher taxable income relative to book income in that period, decreasing the
book-tax gap, while temporary differences that decrease a deferred tax asset, such as write-offs in excess of bad debt
expense, are coded as positive values because they result in lower taxable income compared with book income in
that period, increasing the gap. An assumption underlying these examples is that book income exceeds taxable
income; however, examples hold without this assumption.
18
As mentioned above, the regression analysis requires the change in temporary differences, where temporary
differences are calculated as the change in each net deferred tax asset (liability). This requirement results in the loss
of observations for the first two years of data, eliminating all 1993 and all, but seven, 1994 observations. With only
seven observations, we do not report any summary statistics for 1994 in Table 1; however, we do retain these
observations in the study’s analyses.
15
item in any category.19 Since only material items must be separately reported, 95% of the sample
firms have at least one item in their statement of deferred tax position that is included in
OTHER-t. Additional categories appearing on at least half of the statements of deferred tax
positions are PPE, found 86% of the time, VA and CREDITS-t (credit carryforwards) listed on
53% of the statements, and BENEFITS (employee benefits) on 52%.
The means of the BTD categories vary widely across years. Every category has at least
one year in which its mean value is positive and, except for PPE and INTANG, at least one year
in which its mean value is negative. This is consistent with reversing temporary differences,
where the book revenue (expense) sometimes exceeds the taxable income (deduction) and
sometimes it does not. The mean for ADA (allowance for doubtful accounts) soared in 2007,
consistent with increasing expectations of future write-offs and rising bad debt expense during
the financial crisis. NOL jumped in the late 1990s and remained elevated thereafter, consistent
with Altshuler et al.’s (2008) finding that corporate tax losses soared around the millennium. VA
became increasingly positive over the years, apparently reflecting both the recent economic
downturn that caused ADA to soar and the longer-term effects boosting NOL .
Table 2 shows the mean values for each category across 13 industry groups.20 The largest
industries are Retail with 630 firm-year observations, Durables with 563 observations, and Banks
and Insurance with 468 firm-years. As expected, the key BTDs vary substantially across
industries. This variation is the reason we control for industry in our estimates of equation (5);
however, we find that results are insensitive to the inclusion of industry controls. The industry
19
The suffix “t” denotes temporary differences from the statement of deferred tax position and an “r” denotes
disclosures from the rate reconciliation. Some items, such as credits, can be found on both the statement of deferred
tax position and the rate reconciliation. Thus, the suffix is used to distinguish between the two.
20
Table 2 does not report the 46 firm-years for the industry category ‘Other’, which includes four real estate, nine
agriculture, and 34 firm-year observations for conglomerates that do not fit neatly into one industry: General
Electric, Berkshire Hathaway and Tyco. We do retain all 46 of these observations in the tests in the study.
16
variation suggests that studying BTDs within, as opposed to across, industries might yield
fruitful results. However, inferences are unaltered when we run regressions by industry in
supplemental analyses later in the paper.
3.3.3. Categories from the Rate Reconciliation
Table 3 presents descriptive statistics for the 19 rate reconciliation categories. The format
is identical to that used in Table 1, except we add a column that reports the sample mean as a
percent of pre-tax book income (since rate reconciliations are typically expressed in reference to
the U.S. statutory tax rate of 35%). Reconciling items that increase (decrease) the effective tax
rate are listed as negative (positive) values to reflect their effect on the book-tax gap; items are
shown in millions of dollars of income.
Unlike the means for the temporary differences which reverse and thus eventually settle
at zero, the means for the reconciling items tend to retain the same sign over time and thus are
somewhat worthy of note.21 Interestingly, the two largest categories in absolute value from the
rate reconciliations are actually not differences in book and taxable income.22 Instead, they are
tax rate differentials. FOR-r (incremental foreign tax rate) is the largest item with an average of
$78 million. Its positive mean value indicates that, on average, U.S. companies enjoy lower taxes
21
For example, the annual mean values for AMORT-GW (amortization of goodwill), AMORT-OTH (amortization of
other intangibles), and STATERATE are always negative, indicating that these items usually increase the effective
tax rate. The annual mean values for CREDITS-r (credits), DIVS (non-taxable dividends, including the dividendsreceived deduction), ETI (export incentives, such as the foreign sales corporation exemption), OTHER-r, and TEI
(tax-exempt interest) are always positive, indicating that these items generally decrease the effective tax rate.
22
Note that the term, book-tax differences, which implies differences in book income and taxable income, is a
misnomer in the literature because non-income items, such as the foreign and state rate differentials, are typically
included in measures of aggregate BTDs. The reason is that studies, such as HLS, that estimate aggregate BTDs by
taking the difference between current tax expense (grossed-up) and pre-tax book income capture both BTDs and
non-BTDs and are unable to segregate the two groups. By hand collecting data from the statement of deferred tax
positions and rate reconciliations, this study is able to identify these non-BTDs. We could drop these non-BTDs
from our analysis because this study addresses differences between book and taxable income. However, this would
prevent us from tying out our disaggregated findings to the aggregated ones from HLS. Therefore, we follow the
literature, retain the non-BTDs in the investigation, but separately identify them in our tests so that we can isolate
the impact of actual differences in book income and taxable income on share prices.
17
on foreign income than they do on domestic income.23 Immediately behind FOR-r is
STATERATE (incremental state tax rate) at -$76 million, a negative value arising from state
corporate income taxes. No other reconciling items average over $35 million in absolute value.
As with the statement of deferred tax position, the most common item in the rate reconciliation is
one that cannot be classified into any category because it is insufficiently labeled. An item
categorized as OTHER-r has an entry on 88% of the rate reconciliations. STATERATE at 80% is
the only other reconciling item appearing on over half of the reconciliations.
Table 4 (as with Table 2) shows the mean values for each category across 13 industry
groups. As with the temporary differences, the reconciling items vary considerably across
industries. However, the two tax rate differentials dominate most industries. FOR-r has the
largest mean value in absolute terms in Food, Chemical, Pharmaceuticals, Extraction,
Computers, and Other. In these industries, FOR-r is always negative and far exceeds any other
items, indicating how important foreign taxes are to companies in those industries. STATERATE
is the largest item in the Textile, Retail and Services industries and is barely exceeded by
CREDITS-r among Utilities. ADJTR is the largest item in Mining and Durables, consistent with
both industries being underprovided. AMORT-GW dominates the Transport industry. Not
surprisingly, TEI more than doubles any other item for Banks and Insurance.
23
Recall that we state everything in the conventional BTD approach of book income less taxable income. Thus, a
positive number for a reconciling item implies that the actual current tax expense is less than would be anticipated if
all book income were taxed at the Federal tax rate of 35%. Likewise a negative number implies that the actual
current tax expense is greater than would be expected if book income were only taxed at 35%.
18
4. Regression Results
4.1. Descriptive Statistics
This section presents our findings from estimating equation (5). We begin with
descriptive statistics for the regression variables in Table 5.24 The first column indicates the
number of non-zero observations for that regression variable. The second (third) column
indicates the mean (median) value in millions of dollars of income for the non-zero observations.
The fourth column presents the mean scaled by lagged market value of equity for the non-zero
observations only. The final column presents the mean of the scaled regression variable for the
entire sample. For example, 1,011 of the 3,725 firm-year observations have a non-zero value for
∆ADA (change in allowance for doubtful accounts). The mean (median) for those 1,011 non-zero
observations is -$17.7 (-$0.5) million. When scaled by beginning MVE, the mean value for
∆ADA for those 1,011 observations is 0.017%. Finally, the mean of ∆ADA over all 3,725
observations is 0.005% of beginning MVE.
Based on our estimate of their possible information content, we separate the 22 temporary
differences into three groups based on the discussion in section 2: ∆AQ BTD, ∆TAX BTD-t, and
∆NO INFO BTD-t. Each of the 14 temporary differences in the ∆AQ BTD group potentially
provides investors with information about the accrual quality of the firm. For example, investors
may interpret an unexpected decline in the book-tax difference in the allowance for doubtful
24
Note that for purposes of constructing regression variables, the temporary difference for each category of deferred
tax asset (liability) is calculated by subtracting the prior year’s balance in the deferred tax position from the current
year balance; these “levels” of BTDs are presented in Tables 1 and 2. The regression variable is calculated as the
change in each temporary difference (itself already a change variable), divided by the market value of equity at the
beginning of the year. For example, the revenue variable, REV, was $2,598 for Hewlett Packard in 2007; this
includes disclosures about deferred revenue and intercompany profits. In 2006 and 2005, this variable was $2,063
and $1,220, respectively. The 2007 temporary difference is calculated as ($2,598-$2,063) = $535; the 2006
temporary difference is calculated as ($2,063-$1,220) = $843. The unscaled REV variable for 2007 is the change in
the temporary difference, so ($535 - $843) = -$308. This implicitly assumes that we expected an increase in the REV
BTD of $843 and instead Hewlett Packard reported an increase of only $535 so our “surprise” is $308 less change in
REV than we expected. The REV regression variable for 2007 is equal to 0.29% of MVE at the end of 2006.
19
accounts (a positive value for ∆ADA) as evidence that the accrual quality of the firm is declining
since the bad debt provision, which is expensed for book purposes, is less than the bad debt
write-offs, which are deductible for tax purposes. The six temporary differences in the ∆TAX
BTD-t group potentially provide investors with information about the firm’s current and future
tax obligations. For example, suppose an unexpected increase in credit carryforwards indicates
that credit carryforwards rose during the year, suggesting that future tax liabilities will be lower
than would have been expected at the beginning of the year. Then, this unexpected increase
would be reflected as a negative value for ∆CREDITS-t. Two temporary differences are
classified in the ∆NO INFO BTD-t. We do not expect investors to find these BTDs informative
because neither is sufficiently described in the tax footnote. For example, ∆OTHER-t, are
temporary differences that are labeled as “other,” presumably inadequate description for
investors.
Likewise, we separate the 19 permanent differences into three groups: ∆TAX BTD-r, ∆NO
INFO BTD-r, and ∆NON-BTD. The reasons for the first two categories are identical to those of
similar names in the temporary difference groups. ∆AMORT-GW is an example of a reconciling
item in the ∆TAX BTD-r group. An increase in the ∆AMORT-GW is consistent with a firm
increasing its expenses for books, compared with its deductions for tax, more this year than it did
the prior year. This might communicate to investors that future tax liabilities will be lower than
would have expected based on last year’s rate reconciliation, because more taxable losses than
had been anticipated are forthcoming. We include in ∆NO INFO BTD-r three reconciling items,
including those labeled as “other” (∆OTHER-r), that appear inadequately labeled for investors to
find them informative. Finally, the ∆NON-BTD group includes seven reconciling items that do
not involve differences in book income and taxable income; however, they are captured in the
20
HLS measure of estimated taxable income. For example, as mentioned above, ∆STATERATE
(the incremental tax rate attributable to state income taxes) is not a difference between book
income and taxable income. It is the additional tax levied at the state level, rather than
differences in the income measures for book and tax.
Not surprisingly, the annual changes in BTDs are not a large percentage of MVE. Table
5, Panel A shows that the sum of changes in all of the temporary differences (∆Temporary) are
generally positive (mean ∆Temporary is 1.161%). The sum of changes in the accrual quality
temporary differences (∆AQ BTD) also are positive, on average (mean ∆AQ BTD of 1.093%);
however, the sum of changes in the temporary differences related most closely to tax liabilities
are negative (the mean ∆TAX BTD-t equals -0.065%). Table 5, Panel B shows that total changes
in permanent differences are positive (mean ∆Permanent is 0.010%), indicative of unexpected
permanent differences decreasing the effective tax rate, on average. Changes in those permanent
differences that potentially communicate information about the firm’s tax liabilities also are
positive (mean ∆TAX BTD-r equals 0.009%).
4.2. Primary Findings
Table 6 presents coefficient estimates from various regressions.25 Column A replicates
the HLS model, expressed in equation (1). As HLS did, we find that the coefficients on both
pretax book income (∆PTBI) and estimated taxable income (∆TI) are positive and significant,
using a one-tailed test.26
25
We compute the variance inflation factors for all test variables reported in table 6. The vast majority of these
factors are between 1 and 2. The largest one is 8.3. Thus we conclude that we do not have serious issues with
multicollinearity.
26
Using their sample and methodology, we replicate HLS (untabulated). While we find a significant coefficient on
∆TI in table 6, that we are unable to find as strong a relation as HLS is likely attributable to differences in the
periods investigated, their use of the Fama-McBeth methodology compared with our use of a pooling approach,
and/or differences in samples, including our smaller sample size, which reduces the power of our tests.
21
Column B repeats the same estimation; however, it splits ∆TI into two parts. Recall that
HLS estimate taxable income by grossing up current tax expense and adjusting for net operating
loss carryforwards. The regression reported in column B reports a coefficient on the grossed up
current tax expense (∆CTE) and a coefficient on the NOL carryforward adjustment
(∆NOL_ADJ), signed so that ∆TI equals ∆CTE plus ∆NOL_ADJ.27 We find that that the
coefficient on ∆CTE quadruples the coefficient on ∆TI and is highly significant, while the
coefficient on ∆NOL_ADJ is insignificant.28 Because the two parts of the change in estimated
taxable income carry such different coefficients, the remainder of the tests reports both parts.29
Column C shows the results from our initial estimate of equation (5). The coefficient on
∆ALL is positive, but insignificant. The insignificance of the coefficient means that the difference
between the HLS aggregated measure of BTDs and the sum of our hand-collected BTDs is not
significantly different, which is not surprising but is comforting.30 To undertake a finer analysis,
we trichotomize ∆ALL into ∆Temporary (change in all temporary differences), ∆Permanent
27
We do not predict a sign on the coefficient on ∆NOL_ADJ because a change in an NOL carryforward can be
caused not only by creation or usage of an NOL but also by expiration of an NOL carryforward and so we are
unsure what information the change in the NOL carryforward will convey to the market. We continue to expect a
positive coefficient on ∆CTE because it is the primary component of ∆TI and prior research finds a positive relation
using ∆TI.
28
The dramatic difference between the ∆TI coefficient in column A and the ∆CTE coefficient in column B is
surprising because the NOL adjustment is a small component of the change in estimated taxable income. The mean
value of the ∆CTE regression variable is 0.95, compared with a mean value for the ∆NOL_ADJ regression variable
of only -0.09. A possible explanation for the radical change in that ∆CTE and ∆NOL_ADJ are positively correlated
at the 0.01 level.
29
As an aside, the literature is split on whether to adjust the grossed-up current tax expense by the change in the net
operating loss carryforward. For example, besides HLS, Ayers et al (2009) and Raedy (2009) adjust for the NOL
carryforward. Conversely, Weber (2009), Lev and Nissim (2004), Shevlin (2002), and Manzon and Plesko (2002)
do not adjust for the NOL carryforward in their calculation of taxable income. This split may explain some of the
conflicting results in the literature. We are unable to find theory to guide this computation, but, since it radically
alters the coefficient on taxable income in this paper, we would encourage other researchers to test whether it
materially affects the inferences that they draw from their studies.
30
A significant coefficient on ∆ALL would have suggested that the differences between how HLS compute aggregate
BTDs and how we compute disaggregated BTDs were so large as to potentially undermine our ability to continue
the study. The reason is that it would be difficult to determine whether estimated regression coefficients on the
disaggregated BTDs in equation (5) reflected computational differences between HLS and us or actual differences in
information content.
22
(change in all permanent differences), and ∆NON-BTD (change in all non-BTD items). Column
D shows that none of the coefficients on these three groups is significantly different from zero.
In column E, we further subdivide ∆ Temporary into those BTDs that may provide
information about accrual quality (∆AQ BTD), information about tax payments (∆TAX BTD-t),
and those that have such nondescript labels that we doubt that they can provide any information
(∆NO INFO BTD-t). None of the coefficients is significantly different from zero. In column E,
we also separate the ∆Permanent BTDs into those related to taxes (∆TAX BTD-r) and those with
non-descriptive labels (∆NO INFO BTD-r). Again, neither coefficient is significant.
In column F, presented in Panel B, we replace the subgroups with each of the 41
individual BTDs. While we find that the model in column F is better specified than the model in
column B, only three of the 41 coefficients on the detailed BTDs are significant.31 Since we
could expect a few coefficients to be significant by chance, we infer from these findings that
there is little evidence that investors distinguish among the different BTDs in the statements of
deferred tax accounts and the rate reconciliations when pricing stocks. This is comforting for
researchers who do not have access to the specific BTDs, as we do in this study, because the
findings suggest that aggregated BTDs are probably adequate for purposes of pricing stocks.
That said, it is puzzling to find that aggregated BTDs seem to matter to investors, as indicated by
the prior studies and confirmed in this investigation (by the significant coefficient on ∆CTE);
however, investors appear to find no differences in information content across specific book-tax
differences. We would have expected investors to examine the individual items in the statements
of deferred tax positions and the rate reconciliations and price each one accordingly. The
findings are not consistent with individualized pricing expressing itself as aggregated BTDs
31
A Wald test finds that columns C, D, and E do not significantly improve the model in column B at the 10% level.
However, the detailed model in column F is significantly better than the model in column B at the 5% level.
23
having information content. Further work is needed to explain why the whole of BTDs is greater
(to investors) than the sum of its parts.
Since the three significant coefficients in column F may reflect the fact that some of the
41 coefficients are likely to be significant by chance alone, we are cautious in placing too much
reliance on them. However, when we focus on the three significant coefficients, we see that the
∆VA coefficient is positive. This suggests that investors view a shrinking valuation allowance as
providing evidence about future profitability, consistent with Kumar and Viswanathan (2003),
rather than that managers are using the valuation allowance to manage earnings. Another
significant coefficient is ∆M&A-t, which is negative, consistent with investors viewing current
expenses associated with mergers and acquisitions as good news because they are a harbinger of
future tax deductions. Finally, the coefficient on ∆ADJTR is positive, consistent with investors’
viewing restatements of deferred tax balances as evidence of lower future tax payments.32
4.3. Supplemental Industry Analysis
Given the lack of significance in the main tests, we now turn to a focused, by-industry
analysis in an attempt to increase power and determine whether the Table 6 results are driven by
disparate firms and disclosure practices. For each industry, we determine the four disaggregated
BTDs with the largest change, in absolute value, which are also disclosed by at least half of the
observations in that industry. We require disclosure by at least half the observations in the
industry to ensure that a few outliers are not driving our identification of the important BTDs.
32
∆VA and ∆ADJTR both relate to changes in the Valuation Allowance—as calculated from the statement of
deferred tax positions and from the rate reconciliation, respectively—and so are highly correlated (coefficient of
0.86, significant at the 1% level.) When either is omitted from the regression, the remaining Valuation Allowance
variable becomes insignificant without changing the sign or significance of any other variables.
24
The regression remains as specified in (5), except that only the four most ‘important’ categories
of BTDs are included, not all disclosed BTDs.
Table 7 presents the by-industry regressions. We find that certain BTDs matter in certain
industries. For example, ∆INTANG is positive and significant in the Computers industry and
∆PPE and ∆REG-t are both positive and significant in the Utilities industry.33 What remains
striking, however, is the general lack of significance. In seven of the thirteen industries, not a
single one of the four ‘important’ disaggregated BTDs is significant. Assuming relative
homogeneity of firms within each industry, the lack of significance does not appear to be a
power issue as we report zero significant disaggregated BTDs for the three largest industries
(Retail, Durables, and Banks & Insurance). On average, only one disaggregated BTD matters for
each industry.34
4.4. Extensions
There is no reason to expect that investors scrutinize the BTDs of all firms the same, as
implicitly assumed in the primary tests above. Thus, we undertake two (untabulated) extensions
in an attempt to identify firms whose BTDs might be analyzed differently. Neither extension
provides any evidence that investors view the BTDs of firms differently.
33
Note that a positive coefficient on the change in a temporary difference suggests that investors view a decreasing
DTL or increasing DTA (both which increase the book-tax gap, ceteris paribus) as good news. This result is counter
to the idea that investors interpret a large or increasing book-tax gap as evidence of earnings management and
punish for this behavior.
34
Surprisingly, we find that the coefficients on ∆PTBI and ∆CTE are each significant in less than half of the thirteen
industry groups. In a simple untabulated regression that includes only ∆PTBI, the coefficient on ∆PTBI is significant
in nine of the thirteen industry groups. When we truncate or rank the data, the number of industry groups for which
∆PTBI is significant in this simple regression increases to ten and twelve, respectively. This gives us confidence that
the regression specification is reasonable. When similar rankings are applied to the regressions reported in Table 6,
inferences are largely unaltered. Note that we cannot truncate the sample using all the variables in Tables 6 and 7
without sacrificing a significant percentage of the sample.
25
In our first extension, we identify a set of firms whose accrual quality would appear in
some question. Following Blaylock et al. (2010), we identify suspected earnings managers as
firms whose discretionary accruals (in absolute value) place them in the top quartile of their
industry-year, where industry-years are computed using all firms in the Compustat database.35
We then interact an indicator for these observations (which comprise 7% of our firm-years) with
the current set of explanatory variables and include the interactions and the indicator as
additional explanatory variables. Finding a negative coefficient on the ∆AQ BTD interaction will
be interpreted as evidence that investors assess accrual quality more through the AQ BTDs for
suspected earnings managers than they assess it through the AQ BTDs with other firms. We find
that the interaction with ∆AQ BTD is insignificant. Thus, these results provide no evidence that
the market treats the AQ BTDs of companies whose accrual quality is questionable differently
from other firms. In fact, we find no interactions are significant, implying that the firms
identified as earnings managers are treated no differently than other firms along all dimensions.
In our second extension, we anticipate that investors will place more weight on the
changes in the tax-related BTDs of unusually gifted tax avoiders. Since such firms have
demonstrated an ability to sustain low effective tax rates, their value depends critically on
maintaining those low taxes. As a source of incremental information, changes in the tax-related
BTDs might be a red flag to investors that taxes will rise in the future. To test this proposition,
we identify firms as particularly successful at tax avoidance if its five-year cash taxes paid as a
percentage of pretax book income (cash ETR) is in the lowest quintile of its industry-year, where
industry-years are computed using all firms in the Compustat database. As with the first
extension, we include an indicator variable for the 8% of the sample that are particularly adept
35
Another possible indicator of accrual quality is whether firms have restated their earnings. Unfortunately, those
data are not available in computer-readable form before 2000. Thus, we would forgo a substantial portion of our
sample if we used that indicator.
26
tax avoiders and interact it with the other explanatory variables. The coefficients on the
interactions involving ∆TAX BTD-t and ∆TAX BTD-r are insignificant. In fact, we find that no
interactions are significant, implying that the firms identified as gifted tax avoiders are treated no
differently than other firms along all dimensions.
5. Conclusion
To our knowledge, this is the first study that tests the information content of the detailed
book-tax differences in the statements of deferred tax positions and rate reconciliations. Building
from a model that found that the equity markets price aggregated BTDs, we examine thousands
of hand-collected items from the tax footnote to determine which specific BTDs matter to
investors. Contrary to our expectations that investors would price different BTDs differently, we
find little evidence that the equity market finds information in detailed BTD disclosures that is
incremental to the information in the aggregated BTDs.
We find these results baffling. Prior studies show that investors use aggregate BTD
information to help estimate persistence of income, earnings growth, and similar fundamentals.
Based on these earlier findings, we assumed that aggregate BTDs matter because investors
carefully scrutinize the detailed BTDs that comprise the aggregate, gleaning information from
some BTDs and ignoring others that are not informational. We do not find support for that
explanation. Instead, it appears that investors ignore the detail in the tax footnote and assign a
single price to all BTDs. If so, the detailed tax disclosures in the financial statements apparently
matter less to the equity markets than has been inferred from previous studies. Consequently,
further work is warranted to understand how investors process the tax information in the
financial statements.
27
This paper presents the first analysis of new data, constructed to enable scholars to better
understand the role that BTDs play in many settings. Based on the findings in this initial paper,
our understanding of how investors use book-tax differences appears less well developed than
previously thought.
28
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Firms Have Large Book-Tax Differences,” The Accounting Review 80(1): 137-166.
Hanlon, M., S. K. LaPlante, and T. Shevlin, 2005. “Evidence for the Possible Information Loss
of Conforming Book Income and Taxable Income,” Journal of Law and Economics
48(2): 407-442.
Hanlon, M. and S. Heitzman, 2010. “Tax Research: Real Effects, Reporting Effects, and
Governance,” MIT Sloan School of Management working paper.
Hanlon, M., and Maydew, E. (2009). “Book-tax conformity: Implications for multinational
firms.” National Tax Journal , 62, 127-153.
30
Hanlon, M., Maydew, E., and Shevlin, T. (2008). “An unintended consequence of book-tax
conformity: A loss of earnings informativeness.” Journal of Accounting and Economics ,
46, 294-311.
Hanlon, M., and Shevlin, T. (2005). “Book-tax conformity for corporate income: An introduction
to the issues.” Tax Policy and the Economy , 19, 101-134.
Hanlon, M. and J. Slemrod, 2009. “What does Tax Aggressiveness Signal? Evidence from Stock
Price Reactions to New Announcements about Tax Shelter Involvement,” Journal of
Public Economics 93(1-2): 126-141.
Kumar, K, and G. Visvanathan, 2003. “The information content of the deferred tax valuation
allowance,” The Accounting Review 78: 471-490.
Lev, B. and D. Nissim, 2004. “Taxable Income, Future Earnings, and Equity Values,” The
Accounting Review 79(4): 1039-1074.
Lisowsky, P., 2009. “’Seeking Shelter’: Empirically Modeling Tax Shelters Using Financial
Statement Information,” University of Illinois College of Business working paper.
McClelland, J., and Mills, L. (2007). Weighing benefits and risks of taxing book income. Tax
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31
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32
Appendix A
Description of Variables
Temporary Items
Accrual
Quality?
Y
Variable
ADA
Descriptive Name
Allowance for Doubtful Accounts
BENEFITS
CREDITS-t
ENVIRON
Employee Benefits
Tax Credits
Environmental Costs
Y
EXP
Expenses
Y
FOR-t
Foreign Differences
INTANG
Related to Owned Intangible Property
Y
INVENT
LEASE
Y
Y
M&A-t
Inventory
Related to Leased Property
Merger, Acquisition, Divestitures, and
Restructuring
MTM
Mark-to-Market Accounting
Y
NOL
OPEB
OTHER-t
NOL and other Carryforwards
Pensions and Other Post-Employement
Vague Disclosures
Y
PPE
REG-t
Related to Owned Tangible Property
Regulated Entities
Y
REV
STATE
Revenue
State Differences
Y
SUB-t
Subsidiary-related
Infrequent disclosures or disclosures that
cross categories
Valuation Allowance
Warranty
UNUSUAL-t
VA
WARRANTY
Related to
Tax?
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Explanation of line item disclosures
Accounts receivable, Allowance for doubtful accounts, etc.
Accrued or deferred compensation, including vacation pay, stock compensation,
health care costs, etc.
Credit carryforwards, including foreign and state
Accrued environmental obligation, Cost of removal, Decommisioning, etc.
Accrued or deferred expenses, including frequent flyer plans, direct marketing, policy
acquisition, contingent rent, etc.
Foreign affiliates, Foreign investments, Translation adjustments, DISC, Anticipated
repatriation, etc.
Amortization, Goodwill impairments, Acquired intangibles including IPRD, Mortgage
Servicing, etc.
Capitalized inventory, Inventory valuation methods, Intercompany profit in inventory,
Excess or obsolete inventory, etc.
Lease reserves, Gains on sale and leasebacks, Capital leases, Operating leases, etc.
Deferred gain on sale of business, Merger related costs, Deferred acquisition costs,
Discontinued operations, etc.
Basis differential of investments, Derivatives, FAS 115 adjustment, Investment
valuation, etc.
Net Operating Loss Carryforwards, including foreign and state, charitable
contribution carryforwards, etc.
Pensions and other post-employment or post-retirement benefits
Other, Miscellaneous, Accrued charges, Items not currently deductible, etc.
Accelerated depreciation, Asset basis difference, Capitalized interest, Property
valuation, Asset Impairments, etc.
Deferred fuel costs, Regulatory assets, Rate deferrals, etc.
Deferred revenue, Customer discounts, Contract accounting, Deferred gain on sale of
assets, etc.
Deferred state and local income and franchise taxes
Basis difference in unconsolidated subs, Equity in earnings of affiliates, Investment in
JV, Partnership related, etc.
Combined disclosures such as "Accounts receivable and inventory", infrequent
disclosures
Valuation allowances
Warranty reserves and accruals
Appendix A
Description of Variables
Permanent Items
Accrual
Quality?
Relate d to
Tax?
Variable
Descriptive Name
AMORT-GW
Amortization of Goodwill
Y
AMORT-OTH
COLI
DIVS
DMD
Y
Y
Y
Y
M&A-r
MININT
OTHER-r
Other Amortization
Corporate Owned Life Insurance
Non-taxable Dividends
Domestic Manufacturing Deduction
Merger, Acquisition, Divestitures, and
Restructuring
Minority Interest
Vague Disclosures
REG-r
Regulated Entities
Y
SUB-r
TEI
UNUSUAL-r
Subsidiary-related
Tax Exempt Income
Infrequent disclosures
Y
Y
Y
Explanation of line item disclosures
Amortization of goodwill, Impairment of nondeductible goodwill, Tax effect of
purchase accounting, etc.
Acquired in process R&D, Amortization of Intangibles, Nondeductible amortization,
etc.
Corporate owned life insurance, Changes in cash surrender value, etc.
Dividends received deduction, Dividends on ESOP stock, etc.
Domestic production deduction, Manufacturing exemption
Nondeductible acquisition costs, Merger related costs, Divestitures, Exit costs, Gain
on disposal of business, Restructuring charges, etc.
Effect of minority holdings
Other items, Permanent differences, etc.
Regulatory disallowances, Allowance for funds used during construction, Full
normalization, Mirror construction work in progress, etc.
Equity earnings, Gain on sale of subsidiary stock, Impairment of investments in equity
method subs, etc.
Tax exempt income, Nontaxable income, Tax preferred investments, etc.
Infrequent disclosures
Non-Book/Tax Differences, all included in rate reconciliation
Variable
Descriptive Name
ADJTR
Adjustments to deferred tax balances
AUDIT
Audit Adjustments
CREDITS-r
Tax Credits
ETI
Extraterritorial Income
FOR-r
Foreign Differences
REPAT
STATERATE
Effect of Repatriations
State Rate Differential
Explanation of line item disclosures
Adjustment of prior year provision, Effects of enacted rate and law changes,
adjustments to valuation allowance, etc.
Adjustment to prior year tax liability, Audit settlements, Change in reserve for tax
contingencies, FIN 48, etc.
Credits including disclosures related to Investment Tax Credits (ITC) and
amortization of ITC, excludes foreign tax credits which are included in FOR-r
Benefit from export incentives, Extraterritorial income exclusion, Foreign sales
corporation, etc.
Foreign rate differential, Foreign exchange, Foreign tax credits, Withholding taxes,
etc.
Dividend repatriation, Earnings repatriation, APB 23, AJCA repatriation tax, Foreign
dividends, etc.
Effect of state and local taxes
34
Table 1
Sample Means ($M of income) for Temporary Differences Collected from the Schedule of Deferred Tax Positions
Positive values denote decreases (increases) in deferred tax assets (deferred tax liabilities). Negative values denote increases (decreases) in deferred tax assets (deferred tax liabilities).
Variable
ADA
BENEFITS
CREDITS-t
ENVIRON
EXP
FOR-t
INTANG
INVENT
LEASE
M&A-t
MTM
NOL
OPEB
OTHER-t
PPE
REG-t
REV
STATE
SUB-t
UNUSUAL-t
VA
WARRANTY
TOTAL
(n=3725)
Mean
(10.0)
(53.7)
(40.3)
4.40
7.21
4.57
74.7
(1.08)
10.8
9.75
8.57
(49.3)
15.8
(43.4)
165.6
0.96
(2.33)
0.33
35.2
(12.3)
43.5
4.26
173.3
% ne 0
25
52
52
9
14
19
36
33
16
20
28
40
37
95
86
9
30
10
13
39
53
3
(n=305) (n=341) (n=336) (n=350) (n=312) (n=294) (n=263) (n=228) (n=251) (n=275) (n=261) (n=254)
(n=248)
1995 1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
(5.8)
(4.0)
(4.9)
(20.0)
5.3
9.5
(40.9)
(3.9)
11.6
(31.3)
21.0
20.1
(93.2)
8.3
(38.1)
(57.5)
(26.0)
11.7
(16.1)
5.1
(103.3)
(31.2)
(50.5)
(88.1)
(468.2)
104.2
16.3
18.1
(10.5)
(31.4)
(27.3)
(4.5)
(70.3)
(127.0)
(78.4)
(95.5)
(49.0)
(35.5)
(87.6)
(5.5)
3.0
5.4
2.6
2.8
38.8
(18.2)
7.8
3.5
(0.1)
(1.2)
82.8
(66.5)
(7.1)
(7.9)
(9.6)
3.6
24.8
(12.6)
21.3
21.3
39.6
21.8
22.2
(16.9)
6.9
1.5
2.5
(7.8)
(10.9)
(11.8)
(10.6)
19.2
11.7
70.4
42.2
(54.5)
8.2
16.4
1.8
18.9
10.4
9.1
122.5
74.0
46.9
39.3
163.9
72.0
169.0
262.3
48.0
(1.4)
2.3
(1.2)
(4.4)
(0.8)
(4.3)
(1.7)
4.2
(4.0)
12.3
(10.3)
14.6
(19.3)
9.1
1.5
27.3
21.8
15.4
46.7
1.1
13.0
(3.8)
2.0
11.5
5.0
(22.4)
(0.6)
26.2
22.4
(2.8)
28.4
31.0
(56.0)
(5.2)
10.5
(16.2)
(0.8)
72.7
10.3
103.5
(8.2)
58.5
42.7
49.8
(66.6)
(87.5)
(14.1)
119.0
23.7
(139.9)
16.0
(20.6)
8.3
(14.8)
1.0
(33.5)
(45.8)
(72.8)
(102.5)
(35.9)
(71.2)
(146.4)
(53.9)
(24.6)
(82.7)
(6.0)
49.4
29.0
8.8
59.4
39.9
45.3
(121.0)
80.0
103.3
(24.7)
(256.7)
158.4
(25.6)
16.0
(22.4)
(56.5)
10.3
(22.1)
(59.6)
11.0
(47.2)
(47.1)
(77.9)
(48.7)
(234.0)
115.7
95.8
90.6
74.1
158.9
254.5
218.0
259.9
235.7
280.4
93.8
329.5
28.7
(4.4)
(20.5)
8.2
(2.8)
7.5
5.8
(1.6)
7.8
22.6
23.3
22.3
(13.8)
(39.0)
1.6
7.0
(8.9)
8.4
(4.0)
(23.6)
(10.2)
(17.2)
(21.8)
5.3
40.4
(0.7)
(12.4)
4.4
3.2
4.4
(0.7)
(4.6)
1.7
(1.3)
0.6
5.2
(1.3)
0.6
0.5
(10.4)
6.9
(1.6)
6.7
12.5
72.8
104.7
16.8
5.2
56.2
(1.8)
6.4
185.0
6.3
(9.0)
7.1
(9.5)
(26.2)
(19.9)
17.8
12.3
(8.7)
(14.4)
(49.4)
(124.5)
39.9
25.2
(10.8)
(17.2)
4.6
(0.8)
43.6
23.4
70.1
65.3
95.5
145.7
113.1
58.4
31.2
(0.8)
1.0
0.4
(1.5)
(0.7)
(0.1)
1.4
(3.2)
(1.3)
(10.7)
79.7
(2.2)
(0.9)
200.4
139.8
136.6
(33.9)
498.1
414.6
7.8
7.8
640.3
282.0
(44.8)
227.8
(253.2)
All temporary differences are calculated as the one-year change in the temporary difference category of deferred tax positions; figures are presented in dollars of income. ADA:
bad debt expense (includes allowance for finance receivables if filer is a bank). BENEFITS: bonus accrual expense; accrued compensation expense; accrued vacation expense;
accrued healthcare expense; employee stock plan expenses; workers compensation expense; other employment benefits; items that contain combinations of employment benefits,
other post-employment benefits, and pensions. CREDITS-t: credit carryforwards. ENVIRON: asset retirement/abandonment obligation expenses; accrued environmental expenses;
decommissioning reserves/removal costs; depletion expenses; emission allowances; mineral reserves; exploration costs. EXP: advertising/marketing/promotion expenses; member
acquisition costs; policy acquisition costs; loan origination costs; travel reward program expenses; other expenses. FOR-t: currency translation adjustments; taxes on unremitted
profits; deductions related to foreign subsidiaries; deferred foreign income taxes; foreign inventory adjustments. INTANG: acquired intangible assets (including goodwill); start-up
and organization costs; capitalized research and development; software development costs; mortgage servicing rights; franchise costs; license costs; research and development
write-offs. INVENT: capitalized inventory under UNICAP; intercompany profit in inventory, inventory valuation adjustments. LEASE: capital lease adjustments by the lessee;
gains from sale-leaseback transactions; lease-related expenditures. M&A-t: acquisition/merger-related costs; gains/losses on the sale of subsidiaries or business units, restructuring
35
and reorganizational costs; discontinued operations. MTM: unrealized gains/losses on available-for-sale securities; unrealized gains/losses on non-available-for-sale securities;
items that contain both available-for-sale and not available-for-sale securities; it includes derivative and hedging activities. NOL: net operating loss carryforwards; capital loss
carryforwards; charitable contribution carryforwards. OPEB: pension expenses; other post-employment benefit expenses. OTHER-t: line items too vague to categorize (e.g., “other
adjustments”); includes items which are partially but not fully categorizable (e.g., “accounts receivable and inventory”). PPE: difference between book and tax depreciation or
property; allowance for funds used during construction; asset impairments/write-downs; asset valuation reserves; assets held for sale; items that contain both depreciation and
intangible amortization. REG-t: adjustments unique to regulated entities; unrecovered gas and fuel costs; unamortized nuclear costs; statutory contingency reserves; rate refunds
and rate case costs; power purchase agreements. REV: accrued dividends and royalties, advance payments; contract accounting differences; intercompany receivables; customer
deposits, customer discounts; unearned revenue; other deferred income/revenue; completed contract method of accounting; present value of future profits; deferred lease revenue.
STATE: state and local franchise and income taxes; valuation allowances on state deferred taxes. SUB-t: subsidiary, partnership, and joint venture investments; equity-method
subsidiary investments; earnings from partnerships and joint ventures. UNUSUAL-t: all line items not included in another category. They are material enough to warrant separate
disclosure for that firm but occur too infrequently in the sample to warrant a separate category. VA: change in the valuation allowance. WARRANTY: warranty reserves and
accruals.
36
Table 2
Sample Means ($M of income) for Temporary Differences Collected from the Schedule of Deferred Tax Positions
Positive values denote decreases (increases) in deferred tax assets (deferred tax liabilities). Negative values denote increases (decreases) in deferred tax assets (deferred tax liabilities).
(n=468)
variable
ADA
BENEFITS
CREDITS-t
ENVIRON
EXP
FOR-t
INTANG
INVENT
LEASE
M&A-t
MTM
NOL
OPEB
OTHER-t
PPE
REG-t
REV
STATE
SUB-t
UNUSUAL-t
VA
WARRANTY
TOTAL
(n=57)
(n=212)
(n=169)
(n=83)
(n=162)
(n=190)
(n=563)
(n=351)
(n=282)
(n=394)
(n=630)
Mining
Food
Textile
Chemical
Pharma
Extraction
Durables
Computers
Transport
Utilities
Retail
0.0
(11.2)
(9.5)
0.0
0.0
0.1
0.1
(93.2)
0.3
(0.8)
(0.7)
0.1
0.0
(39.1)
2.5
0.0
1.0
0.0
(3.0)
(25.5)
74.7
(5.3)
0.0
(41.5)
(1.0)
0.1
0.9
12.6
79.9
2.0
(1.3)
10.0
0.9
(29.9)
(4.1)
0.0
18.0
0.0
(1.1)
(0.5)
27.1
(31.1)
25.9
0.0
(0.3)
(18.3)
(23.7)
47.3
3.1
2.2
16.9
(0.0)
(0.7)
1.2
(0.2)
(19.2)
(2.5)
(3.3)
18.2
0.0
4.7
(2.0)
0.2
(7.5)
29.8
0.0
0.1
(21.1)
(145.9)
0.1
(5.5)
(4.5)
401.3
(17.1)
(1.7)
19.2
(7.4)
(6.7)
12.4
(100.0)
21.4
0.0
(5.5)
(0.0)
5.3
(15.3)
44.0
0.0
(4.3)
(138.1)
(118.3)
1.5
(10.4)
47.8
132.8
(37.9)
(0.9)
22.0
(5.2)
(33.0)
14.2
(130.2)
25.4
0.0
(21.9)
(10.9)
15.0
(53.2)
62.9
0.0
(0.7)
(62.6)
(105.7)
46.4
0.0
16.7
30.3
(3.9)
6.5
4.2
(7.5)
(77.5)
(48.0)
(38.3)
942.7
11.8
0.5
(3.3)
47.9
7.0
111.3
0.0
12.2
(7.1)
(25.5)
(0.2)
(2.7)
(15.8)
24.1
2.8
30.7
12.5
4.2
(94.9)
54.7
(38.2)
19.7
0.0
(6.1)
1.6
0.0
(48.6)
78.6
31.8
(8.2)
(62.2)
(94.0)
0.0
(0.2)
59.9
18.4
(8.7)
6.6
16.7
3.4
(32.3)
42.5
(43.1)
(8.0)
0.0
(62.5)
(1.3)
0.8
(5.7)
50.5
(5.0)
(109.6)
67.1
45.9
173.0
(242.9)
877.8
33.8
(132.1)
9.4
(159.5)
(3.0)
(4.4)
(9.3)
(5.1)
290.4
(0.1)
15.7
4.3
(39.3)
(173.5)
63.8
(63.9)
770.4
1.5
21.0
7.0
415.1
8.5
104.9
0.0
1,254.0
Banks &
Insurance
(n=118)
Services
0.9
(8.0)
(13.9)
1.6
0.0
(1.4)
5.1
4.7
15.8
(0.7)
4.7
(13.6)
(8.9)
(8.2)
248.3
2.6
(2.4)
6.8
(2.4)
0.1
7.8
0.0
(1.0)
(17.9)
(10.5)
0.1
(5.5)
0.0
17.0
14.9
(0.9)
(2.9)
(1.7)
(7.9)
(0.6)
(15.5)
62.7
0.0
6.5
(1.5)
0.1
(7.8)
15.0
0.0
(86.0)
(136.2)
(44.9)
0.0
76.8
(14.3)
147.9
0.0
3.4
31.0
9.0
(55.8)
3.3
(71.9)
77.3
(0.2)
17.2
(0.1)
(5.7)
(24.1)
6.6
0.0
(2.6)
(19.9)
(6.3)
0.0
0.1
(0.0)
(2.3)
0.0
0.7
13.2
9.0
(15.1)
1.8
(9.8)
84.3
0.0
(9.2)
(0.4)
(1.6)
32.8
4.6
0.0
239.0
42.5
(66.9)
79.4
All temporary differences are calculated as the one-year change in the temporary difference category of deferred tax positions; figures are presented in dollars of income. ADA:
bad debt expense (includes allowance for finance receivables if filer is a bank). BENEFITS: bonus accrual expense; accrued compensation expense; accrued vacation expense;
accrued healthcare expense; employee stock plan expenses; workers compensation expense; other employment benefits; items that contain combinations of employment benefits,
other post-employment benefits, and pensions. CREDITS-t: credit carryforwards. ENVIRON: asset retirement/abandonment obligation expenses; accrued environmental expenses;
decommissioning reserves/removal costs; depletion expenses; emission allowances; mineral reserves; exploration costs. EXP: advertising/marketing/promotion expenses; member
acquisition costs; policy acquisition costs; loan origination costs; travel reward program expenses; other expenses. FOR-t: currency translation adjustments; taxes on unremitted
profits; deductions related to foreign subsidiaries; deferred foreign income taxes; foreign inventory adjustments. INTANG: acquired intangible assets (including goodwill); start-up
and organization costs; capitalized research and development; software development costs; mortgage servicing rights; franchise costs; license costs; research and development
write-offs. INVENT: capitalized inventory under UNICAP; intercompany profit in inventory, inventory valuation adjustments. LEASE: capital lease adjustments by the lessee;
gains from sale-leaseback transactions; lease-related expenditures. M&A-t: acquisition/merger-related costs; gains/losses on the sale of subsidiaries or business units, restructuring
37
and reorganizational costs; discontinued operations. MTM: unrealized gains/losses on available-for-sale securities; unrealized gains/losses on non-available-for-sale securities;
items that contain both available-for-sale and not available-for-sale securities; it includes derivative and hedging activities. NOL: net operating loss carryforwards; capital loss
carryforwards; charitable contribution carryforwards. OPEB: pension expenses; other post-employment benefit expenses. OTHER-t: line items too vague to categorize (e.g., “other
adjustments”); includes items which are partially but not fully categorizable (e.g., “accounts receivable and inventory”). PPE: difference between book and tax depreciation or
property; allowance for funds used during construction; asset impairments/write-downs; asset valuation reserves; assets held for sale; items that contain both depreciation and
intangible amortization. REG-t: adjustments unique to regulated entities; unrecovered gas and fuel costs; unamortized nuclear costs; statutory contingency reserves; rate refunds
and rate case costs; power purchase agreements. REV: accrued dividends and royalties, advance payments; contract accounting differences; intercompany receivables; customer
deposits, customer discounts; unearned revenue; other deferred income/revenue; completed contract method of accounting; present value of future profits; deferred lease revenue.
STATE: state and local franchise and income taxes; valuation allowances on state deferred taxes. SUB-t: subsidiary, partnership, and joint venture investments; equity-method
subsidiary investments; earnings from partnerships and joint ventures. UNUSUAL-t: all line items not included in another category. They are material enough to warrant separate
disclosure for that firm but occur too infrequently in the sample to warrant a separate category. VA: change in the valuation allowance. WARRANTY: warranty reserves and
accruals.
38
Table 3
Sample Means ($M of income) for Items from the Rate Reconciliation
Positive (negative) values denote reconciling items that decrease (increase) the effective tax rate.
Variable
ADJTR
AMORT-GW
AMORT-OTH
AUDIT
COLI
CREDITS-r
DIVS
DMD
ETI
FOR-r
M&A-r
MININT
OTHER-r
REG-r
REPAT
STATERATE
SUB-r
TEI
UNUSUAL-r
TOTAL
(n=3725)
(n=3725)
Mean $M Mean %PI
(11.1)
10.69%
(25.9)
-8.21%
(19.2)
-1.62%
25.6
1.56%
0.45
0.10%
34.9
2.40%
7.11
0.40%
1.64
0.10%
9.53
0.89%
77.8
5.03%
(1.28)
-0.62%
0.50
0.01%
11.5
0.91%
(1.95)
-0.32%
(11.2)
0.13%
(76.0)
-6.97%
12.2
0.56%
30.8
3.09%
(8.57)
0.56%
56.9
8.7%
% ne 0
26
16
9
18
2
30
10
2
9
48
6
2
88
7
7
80
6
12
15
(n=305) (n=341) (n=336) (n=350) (n=312) (n=294) (n=263) (n=228) (n=251) (n=275) (n=261) (n=254) (n=248)
1995 1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
12.1
5.7
1.2
8.3
0.6
(7.0)
(25.9)
(27.6)
(21.6)
(93.9)
(53.1)
15.6
23.8
(8.7)
(9.2)
(23.1)
(20.0)
(20.9)
(24.4)
(30.9)
(17.1)
(32.1)
(10.3)
(7.4)
(8.4) (141.4)
(12.7)
(15.6)
(19.3)
(42.9)
(17.6)
(23.2)
(25.2)
(19.8)
(23.6)
(9.3)
(7.7)
(14.5)
(13.1)
3.3
6.1
7.3
10.2
3.5
7.4
(8.5)
17.8
28.2
55.6
109.6
87.8
31.6
0.5
0.7
0.5
0.1
(0.4)
(2.5)
(0.0)
0.6
0.6
1.2
1.3
1.4
2.6
14.2
16.8
18.8
18.8
24.5
28.4
40.1
39.2
42.6
55.7
62.0
53.4
64.1
3.4
3.5
4.1
3.6
4.4
5.1
3.8
11.1
8.9
11.1
11.9
11.9
15.3
0.0
0.0
0.0
(0.0)
0.0
0.0
0.3
0.7
0.9
1.1
4.5
7.4
9.2
3.7
4.7
5.2
6.1
7.7
8.9
10.6
11.0
9.5
23.9
23.5
9.4
4.4
(1.5)
(9.9)
(5.9)
23.1
45.4
51.1
62.5
108.4
139.6
166.7
181.6
165.1
189.5
3.2
2.8
16.3
(1.7)
(9.7)
(28.2)
(30.9)
21.9
5.8
4.0
2.5
0.9
(2.4)
1.2
(0.6)
0.9
2.8
1.5
1.0
1.4
0.9
(1.3)
(1.9)
(0.3)
0.1
0.0
0.7
9.3
12.0
8.4
2.5
6.1
2.9
2.4
25.9
18.4
26.8
21.9
18.0
(1.7)
(3.3)
(4.0)
(4.4)
(4.0)
(5.6)
(1.6)
0.4
(0.4)
(0.5)
(0.1)
0.8
2.3
(7.2)
(1.7)
0.6
(1.7)
(2.3)
(0.4)
(2.6)
(0.1)
7.0
(29.4)
(77.0)
(21.0)
(20.7)
(47.0)
(52.5)
(51.4)
(51.2)
(78.1)
(81.0)
(58.9)
(77.4)
(78.7)
(73.0) (112.8) (137.7) (120.6)
7.9
12.3
7.7
7.2
5.1
(18.2)
4.8
3.7
28.2
30.3
40.3
18.5
18.6
12.3
12.1
14.9
16.2
21.8
24.7
26.9
31.1
30.0
44.9
51.4
64.9
73.0
(0.6)
(2.5)
(0.4)
(3.2)
(7.8)
(2.4)
(11.1)
3.8
(14.7)
(68.9)
(19.0)
3.6
9.3
(17.0)
(21.3)
(14.6)
(20.5)
(23.9)
(60.3)
(42.3)
111.0
154.7
125.7
238.1
281.1
163.6
All reconciling items are presented in dollars of income, calculated as the effect on the effective tax rate multiplied by income before taxes and divided by the statutory tax rate.
ADJRET: provision to tax return adjustments, adjustment of deferred taxes due to changes in rates or laws, change in the valuation allowance. AMORT-GW: amortization and
impairments of goodwill; effect of non-deductible goodwill; negative goodwill amortization; purchase accounting adjustments. AMORT-OTH: amortization of intangible assets;
nondeductible amortization; includes acquired purchased in-process research and development. AUDIT: audit resolutions and settlements; adjustments of tax reserves or prior year
adjustments; FIN 48 and other tax contingencies. COLI: company-owned life insurance. CREDITS-r: all credits including state, foreign, investment, and alternative minimum tax;
credit carryforwards; expiration of credits. DIVS: non-taxable dividends, including dividends-received deduction. DMD: domestic production activities deduction. ETI: benefits
of FSC and ETI. FOR-r: effects of foreign rates higher or lower than U.S. statutory rate; currency translation adjustments; foreign tax holidays; foreign withholding tax. M&A-r:
merger costs, Gains/losses on the sale or disposal of subsidiaries, restructuring charges. MININT: minority interest. OTHER-r: line items too vague to categorize (e.g.,
“nondeductible expenses”); includes items which are partially but not fully categorizable (e.g., nondeductible goodwill and other). REG-r: items unique to regulated entities.
REPAT: effects of repatriating foreign income. STATERATE: effects of U.S. state income tax rates. SUB-r: equity earnings in affiliates; gain on subsidiary IPO; consolidation
differences; write-downs of equity investments, permanent items flowed-through from subsidiaries. TEI: non-taxable interest and dividends. UNUSUAL-r: all line items not
included in another category. They are material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to warrant a separate category.
39
Table 4
Sample Means ($M of income) for Items from the Rate Reconciliation
Positive (negative) values denote reconciling items that decrease (increase) the effective tax rate.
(n=468)
variable
ADJTR
AMORT-GW
AMORT-OTH
AUDIT
COLI
CREDITS-r
DIVS
DMD
ETI
FOR-r
M&A-r
MININT
OTHER-r
REG-r
REPAT
STATERATE
SUB
TEI
UNUSUAL-r
TOTAL
(n=57)
(n=212)
(n=169)
(n=83)
(n=162)
(n=190)
(n=563)
(n=351)
(n=282)
(n=394)
(n=630)
Mining
Food
Textile
Chemical
Pharma
Extraction
Durables
Computers
Transport
Utilities
Retail
(63.2)
(9.7)
0.0
3.7
0.0
0.4
0.0
3.2
1.9
(1.6)
0.0
0.0
(7.6)
0.0
0.2
(36.8)
0.0
0.0
2.7
8.1
(41.0)
(13.5)
81.4
0.0
4.5
0.0
0.4
6.1
168.3
(3.3)
0.0
25.0
0.0
(35.9)
(106.7)
10.3
0.8
(4.0)
(3.4)
(24.4)
(2.9)
13.8
0.2
21.9
0.8
1.7
7.1
30.9
(3.3)
7.8
27.7
0.0
(13.3)
(32.0)
(0.0)
0.0
(13.1)
9.3
0.0
(23.9)
22.9
0.1
24.6
2.8
0.0
7.3
168.1
(2.5)
0.0
16.2
0.0
9.3
(19.9)
38.5
0.0
7.2
(17.7)
(20.3)
(134.5)
24.7
0.0
60.1
22.4
0.7
0.0
1,067.5
(16.6)
7.8
(20.5)
0.0
(93.5)
(83.0)
8.1
0.0
(16.3)
(106.7)
100.4
19.4
260.0
788.8
35.4
(3.4)
(1.4)
47.1
0.0
60.5
4.3
5.9
7.1
(1,073.7)
7.5
0.0
74.2
0.0
(19.3)
(94.7)
183.0
0.0
(0.3)
(767.6)
Banks &
Insurance
(n=118)
Services
(54.7)
(21.9)
(8.1)
30.7
0.1
28.3
4.6
1.8
32.6
67.8
4.5
(0.4)
7.5
0.0
(5.8)
(23.6)
6.2
0.7
8.4
(54.9)
(24.8)
(38.3)
43.8
0.0
34.5
0.5
2.5
28.7
262.4
(26.5)
(0.0)
(6.0)
0.0
(19.5)
(54.4)
0.8
12.8
8.3
15.9
(126.7)
(75.0)
19.8
0.1
20.7
3.3
0.0
5.1
14.1
6.0
(0.2)
9.1
0.0
(5.4)
(181.5)
(12.6)
0.3
(110.8)
1.2
(9.6)
(3.2)
15.9
0.4
86.4
2.9
6.0
0.0
5.1
3.5
(0.5)
12.8
(18.4)
(2.0)
(72.5)
(0.2)
0.4
(3.8)
(0.1)
(9.5)
(2.0)
5.1
0.3
2.9
1.1
0.0
0.4
25.6
(2.7)
(0.4)
2.8
0.0
(1.0)
(75.2)
1.3
0.9
(0.0)
(0.3)
(8.8)
(2.6)
21.2
2.6
60.0
23.4
0.0
(1.0)
88.9
0.9
0.2
17.2
0.0
(0.9)
(110.5)
4.0
211.3
10.3
1.7
(39.3)
(8.9)
7.5
0.3
21.2
(0.4)
0.0
0.0
11.5
(1.2)
(0.8)
0.3
0.0
(2.1)
(47.8)
(2.1)
8.0
(30.7)
78.7
169.9
(417.6)
24.4
(50.6)
315.9
(82.8)
All reconciling items are presented in dollars of income, calculated as the effect on the effective tax rate multiplied by income before taxes and divided by the statutory tax rate.
ADJRET: provision to tax return adjustments, adjustment of deferred taxes due to changes in rates or laws, change in the valuation allowance. AMORT-GW: amortization and
impairments of goodwill; effect of non-deductible goodwill; negative goodwill amortization; purchase accounting adjustments. AMORT-OTH: amortization of intangible assets;
nondeductible amortization; includes acquired purchased in-process research and development. AUDIT: audit resolutions and settlements; adjustments of tax reserves or prior year
adjustments; FIN 48 and other tax contingencies. COLI: company-owned life insurance. CREDITS-r: all credits including state, foreign, investment, and alternative minimum tax;
credit carryforwards; expiration of credits. DIVS: non-taxable dividends, including dividends-received deduction. DMD: domestic production activities deduction. ETI: benefits
of FSC and ETI. FOR-r: effects of foreign rates higher or lower than U.S. statutory rate; currency translation adjustments; foreign tax holidays; foreign withholding tax. M&A-r:
merger costs, Gains/losses on the sale or disposal of subsidiaries, restructuring charges. MININT: minority interest. OTHER-r: line items too vague to categorize (e.g.,
“nondeductible expenses”); includes items which are partially but not fully categorizable (e.g., nondeductible goodwill and other). REG-r: items unique to regulated entities.
REPAT: effects of repatriating foreign income. STATERATE: effects of U.S. state income tax rates. SUB-r: equity earnings in affiliates; gain on subsidiary IPO; consolidation
differences; write-downs of equity investments, permanent items flowed-through from subsidiaries. TEI: non-taxable interest and dividends. UNUSUAL-r: all line items not
included in another category. They are material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to warrant a separate category.
40
Table 5
Summary Statistics
Fortune 250 firms, 1994-2007
Panel A
Variable
R
n
3725
Mean (%)
8.610
Non-zero observations only
Mean
Median
Mean
($M of income) ($M of income) (% beg MVE)
151.056
64.300
1.293
149.922
28.462
0.858
149.472
28.954
0.949
1.400
(4.581)
(0.283)
Mean
(% beg MVE)
1.293
0.858
0.949
(0.091)
∆ PTBI
∆ TI
∆ CTE
∆ NOL_ADJ
n
3725
3725
3725
1198
∆ Temporary
∆ AQ BTD
∆ ADA
∆ BENEFITS
∆ ENVIRON
∆ EXP
∆ INTANG
∆ INVENT
∆ LEASE
∆ MTM
∆ OPEB
∆ PPE
∆ REV
∆ UNUSUAL-t
∆ VA
∆ WARRANTY
3724
3718
1011
2075
350
572
1410
1311
639
1157
1504
3365
1236
1634
2211
131
(14.732)
28.454
(17.737)
(15.430)
(48.578)
5.369
31.577
(5.048)
(13.283)
(17.270)
43.642
7.066
6.152
(4.670)
22.650
158.523
0.001
1.418
(0.542)
(1.223)
(1.064)
0.689
1.341
(0.253)
(0.286)
(0.483)
0.285
0.502
(0.704)
(0.857)
1.703
(0.449)
1.161
1.095
0.017
(0.325)
0.106
0.123
0.818
(0.011)
0.103
0.290
0.540
0.733
0.033
(0.310)
0.079
0.729
1.161
1.093
0.005
(0.181)
0.010
0.019
0.309
(0.004)
0.018
0.090
0.218
0.662
0.011
(0.136)
0.047
0.026
∆ TAX BTD-t
∆ CREDITS-t
∆ FOR-t
∆ M&A-t
∆ NOL
∆ REG-t
∆ STATE
3226
2152
787
873
1680
383
433
(49.196)
(12.372)
(11.706)
(56.322)
(22.122)
(86.007)
(8.303)
(5.714)
(1.996)
1.429
(9.852)
(6.580)
(0.086)
(0.295)
(0.075)
(0.280)
(0.123)
(0.519)
0.735
(0.837)
(0.011)
(0.065)
(0.162)
(0.026)
(0.122)
0.332
(0.086)
(0.001)
∆ NO INFO BTD-t
∆ OTHER-t
∆ SUB-t
3697
3697
561
(0.527)
(11.709)
73.711
(0.580)
(0.590)
0.001
0.135
0.171
(0.236)
0.134
0.170
(0.036)
Table 5
Summary Statistics
Fortune 250 firms, 1994-2007
Panel B
Non-zero observations only
Mean
Median
Mean
($M of income) ($M of income) (% beg MVE)
6.996
0.165
0.010
8.847
0.017
0.009
13.442
(0.961)
0.158
2.457
(0.070)
(0.230)
2.892
1.402
0.031
7.654
1.142
0.004
25.538
22.000
0.147
(23.364)
(2.841)
(0.088)
3.517
(1.720)
0.018
18.412
2.592
0.056
4.425
(0.031)
0.011
Mean
(% beg MVE)
0.010
0.009
0.030
(0.027)
0.001
0.000
0.004
(0.009)
0.001
0.008
0.002
∆ Permanent
∆ TAX BTD-r
∆ AMORT-GW
∆ AMORT-OTH
∆ COLI
∆ DIVS
∆ DMD
∆ M&A-r
∆ REG-r
∆ TEI
∆ UNUSUAL-r
n
3607
2312
698
430
94
411
91
386
261
507
687
∆ NO INFO BTD-r
∆ MININT
∆ OTHER-r
∆ SUB-r
3531
73
3520
271
1.353
(1.592)
4.185
(36.291)
0.063
(0.642)
0.096
2.286
0.000
0.014
0.008
(0.107)
0.000
0.000
0.008
(0.008)
∆ NON-BTD
∆ ADJTR
∆ AUDIT
∆ CREDITS-r
∆ ETI
∆ FOR-r
∆ REPAT
∆ STATERATE
3592
1114
803
1200
378
1976
348
3146
4.816
(41.783)
11.409
10.549
0.064
27.318
(14.266)
(2.230)
0.376
(0.452)
2.380
0.185
0.520
6.099
(2.256)
(1.839)
(0.086)
(0.526)
0.091
0.065
0.044
0.159
(0.017)
(0.063)
(0.083)
(0.157)
0.020
0.021
0.004
0.084
(0.002)
(0.053)
The dependent variable is Rit , which denotes the market-adjusted return for firm i and is defined as the compound (with
dividend) return less the compound return on the value-weighted market portfolio. Returns are calculated over a 16-month
period, starting at the beginning of fiscal year t and ending four months after the end of the fiscal year t. ∆PTBI is the change in
pretax book income less minority interest. ∆TI is the change in taxable income, which is calculated as current tax expense
(federal current plus foreign current where available, total tax expense less deferred tax expense otherwise) divided by the
statutory rate, adjusted for the change in the NOL carryforward reported by Compustat. ∆CTE and ∆NOL_ADJ break ∆TI into its
two components: ∆CTE is the current tax expense, as calculated above, divided by the statutory rate, while ∆NOL_ADJ is the
amount that ∆TI is affected by the change in NOL carryforwards. ∆Temporary is the sum of the changes in the temporary
difference categories: ∆AQ BTD, ∆TAX BTD-t, and ∆NO INFO BTD-t. ∆AQ BTD is the sum of the changes in the accrual quality
BTD categories: ∆ADA, ∆BENEFITS, ∆ENVIRON, ∆EXP, ∆INTANG, ∆INVENT, ∆LEASE, ∆MTM, ∆OPEB, ∆PPE, ∆REV,
∆UNUSUAL-t, ∆VA, and ∆WARRANTY. ∆TAX BTD-t is the sum of the changes in the tax BTD categories: ∆CREDITS-t, ∆FOR-t,
∆M&A-t, ∆NOL, ∆REG-t, and ∆STATE. ∆NO INFO BTD-t is the sum of the changes in the temporary difference categories in
which the information is too difficult to decipher to be informative: ∆OTHER-t and ∆SUB-t. ∆Permanent is the sum of the
changes in the permanent difference categories: ∆TAX BTD-r and ∆NO INFO BTD-r. ∆TAX BTD-r is the sum of the changes in
the TAX BTD-r categories: ∆AMORT-GW, ∆AMORT-OTH, ∆COLI, ∆DIVS, ∆DMD, ∆M&A-r, ∆REG-r, ∆TEI, and ∆UNUSUALr. ∆NO INFO BTD-r is the sum of the changes in the categories in which the information is too difficult to decipher to be
informative: ∆OTHER-r, ∆MININT, and ∆SUB-r. ∆NON-BTD is the sum of the changes in categories from the rate reconciliation
which pertain to taxes, rather than to differences between book income and taxable income: ∆ADJTR, ∆AUDIT, ∆CREDITS-r,
42
∆ETI, ∆FOR-r, ∆REPAT, and ∆STATERATE. All non-categorical variables are scaled by beginning of year market value of
equity.
The values for each category formed from accounts in the statement of deferred tax positions are computed as the difference
between the values in year t and year t-1 less the difference between the values in year t-1 and year t-2, state in dollars of income.
These categories are: BENEFITS: bonus accrual expense; accrued compensation expense; accrued vacation expense; accrued
healthcare expense; employee stock plan expenses; workers compensation expense; other employment benefits; items that
contain combinations of employment benefits, other post-employment benefits, and pensions. CREDITS-t: credit carryforwards.
ENVIRON: asset retirement/abandonment obligation expenses; accrued environmental expenses; decommissioning
reserves/removal costs; depletion expenses; emission allowances; mineral reserves; exploration costs. EXP:
advertising/marketing/promotion expenses; member acquisition costs; policy acquisition costs; loan origination costs; travel
reward program expenses; other expenses. FOR-t: currency translation adjustments; taxes on unremitted profits; deductions
related to foreign subsidiaries; deferred foreign income taxes; foreign inventory adjustments. INTANG: acquired intangible assets
(including goodwill); start-up and organization costs; capitalized research and development; software development costs;
mortgage servicing rights; franchise costs; license costs; research and development write-offs. INVENT: capitalized inventory
under UNICAP; intercompany profit in inventory, inventory valuation adjustments. LEASE: capital lease adjustments by the
lessee; gains from sale-leaseback transactions; lease-related expenditures. M&A-t: acquisition/merger-related costs; gains/losses
on the sale of subsidiaries or business units, restructuring and reorganizational costs; discontinued operations. MTM: unrealized
gains/losses on available-for-sale securities; unrealized gains/losses on non-available-for-sale securities; items that contain both
available-for-sale and not available-for-sale securities; it includes derivative and hedging activities. NOL: net operating loss
carryforwards; capital loss carryforwards; charitable contribution carryforwards. OPEB: pension expenses; other postemployment benefit expenses. OTHER-t: line items too vague to categorize (e.g., “other adjustments”); includes items which are
partially but not fully categorizable (e.g., “accounts receivable and inventory”). PPE: difference between book and tax
depreciation or property; allowance for funds used during construction; asset impairments/write-downs; asset valuation reserves;
assets held for sale; items that contain both depreciation and intangible amortization. REG-t: adjustments unique to regulated
entities; unrecovered gas and fuel costs; unamortized nuclear costs; statutory contingency reserves; rate refunds and rate case
costs; power purchase agreements. REV: accrued dividends and royalties, advance payments; contract accounting differences;
intercompany receivables; customer deposits, customer discounts; unearned revenue; other deferred income/revenue; completed
contract method of accounting; present value of future profits; deferred lease revenue. STATE: state and local franchise and
income taxes; valuation allowances on state deferred taxes. SUB-t: subsidiary, partnership, and joint venture investments; equitymethod subsidiary investments; earnings from partnerships and joint ventures. UNUSUAL-t: all line items not included in another
category. They are material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to
warrant a separate category. VA: change in the valuation allowance. WARRANTY: warranty reserves and accruals.
The values for each category formed from items in the rate reconciliation are computed as the dollar value in the rate
reconciliation in year t less the dollar value in the rate reconciliation in year t-1. These categories are: ADJRET: provision to tax
return adjustments, adjustment of deferred taxes due to changes in rates or laws, change in the valuation allowance. AMORT-GW:
amortization and impairments of goodwill; effect of non-deductible goodwill; negative goodwill amortization; purchase
accounting adjustments. AMORT-OTH: amortization of intangible assets; nondeductible amortization; includes acquired
purchased in-process research and development. AUDIT: audit resolutions and settlements; adjustments of tax reserves or prior
year adjustments; FIN 48 and other tax contingencies. COLI: company-owned life insurance. CREDITS-r: all credits including
state, foreign, investment, and alternative minimum tax; credit carryforwards; expiration of credits. DIVS: non-taxable dividends,
including dividends-received deduction. DMD: domestic production activities deduction. ETI: benefits of FSC and ETI. FOR-r:
effects of foreign rates higher or lower than U.S. statutory rate; currency translation adjustments; foreign tax holidays; foreign
withholding tax. M&A-r: merger costs, Gains/losses on the sale or disposal of subsidiaries, restructuring charges. MININT:
minority interest. OTHER-r: line items too vague to categorize (e.g., “nondeductible expenses”); includes items which are
partially but not fully categorizable (e.g., nondeductible goodwill and other). REG-r: items unique to regulated entities. REPAT:
effects of repatriating foreign income. STATERATE: effects of U.S. state income tax rates. SUB-r: equity earnings in affiliates;
gain on subsidiary IPO; consolidation differences; write-downs of equity investments, permanent items flowed-through from
subsidiaries. TEI: non-taxable interest and dividends. UNUSUAL-r: all line items not included in another category. They are
material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to warrant a separate
category.
43
Table 6
Estimated Regression Coefficients from Regressing 16-month returns on
on pre-tax book income and taxable income or book-tax differences using Generalized Least Squares
3725 observations, Fortune 250 firms, 1994-2007
Panel A
pred
intercept
∆ PTBI
∆ TI
∆ CTE
∆ NOL_ADJ
(+)
(+)
(+)
A
0.395
0.784 **
0.235 *
B
0.386
0.681 **
C
0.368
0.570 **
D
0.367
0.566 **
E
0.346
0.617 **
1.089 **
-0.008
1.171 **
0.030
1.167 **
0.022
1.149 **
0.047
∆ ALL
∆ Temporary
∆ AQ BTD
∆ TAX BTD-t
∆ NO INFO BTD-t
∆ Permanent
∆ TAX BTD-r
∆ NO INFO BTD-r
∆ NON-BTD
Adjusted R
2
0.116
0.118
0.124
0.068
-0.056
0.028
10.65%
11.96%
12.02%
0.144
0.014
-0.073
0.134
12.03%
12.33%
** (*) significant at the 0.01 (0.05) level, using a two-tailed test where no sign is predicted
The dependent variable is Rit , which denotes the market-adjusted return for firm i and is defined as the compound (with
dividend) return less the compound return on the value-weighted market portfolio. Returns are calculated over a 16-month
period, starting at the beginning of fiscal year t and ending four months after the end of the fiscal year t. ∆PTBI is the change in
pretax book income less minority interest. ∆TI is the change in taxable income, which is calculated as current tax expense
(federal current plus foreign current where available, total tax expense less deferred tax expense otherwise) divided by the
statutory rate, adjusted for the change in the NOL carryforward reported by Compustat. ∆CTE and ∆NOL_ADJ break ∆TI into its
two components: ∆CTE is the current tax expense, as calculated above, divided by the statutory rate, while ∆NOL_ADJ is the
amount that ∆TI is affected by the change in NOL carryforwards. ∆ALL is the sum of all hand-collected differences:
∆Temporary, ∆Permanent, and ∆NON-BTD. ∆Temporary is the sum of the changes in the temporary difference categories: ∆AQ
BTD, ∆TAX BTD-t, and ∆NO INFO BTD-t. ∆AQ BTD is the sum of the changes in the accrual quality BTD categories: ∆ADA,
∆BENEFITS, ∆ENVIRON, ∆EXP, ∆INTANG, ∆INVENT, ∆LEASE, ∆MTM, ∆OPEB, ∆PPE, ∆REV, ∆UNUSUAL-t, ∆VA, and
∆WARRANTY. ∆TAX BTD-t is the sum of the changes in the tax BTD categories: ∆CREDITS-t, ∆FOR-t, ∆M&A-t, ∆NOL, ∆REGt, and ∆STATE. ∆NO INFO BTD-t is the sum of the changes in the temporary difference categories in which the information is
too difficult to decipher to be informative: ∆OTHER-t and ∆SUB-t. ∆Permanent is the sum of the changes in the permanent
difference categories: ∆TAX BTD-r and ∆NO INFO BTD-r. ∆TAX BTD-r is the sum of the changes in the TAX BTD-r categories:
∆AMORT-GW, ∆AMORT-OTH, ∆COLI, ∆DIVS, ∆DMD, ∆M&A-r, ∆REG-r, ∆TEI, and ∆UNUSUAL-r. ∆NO INFO BTD-r is the
sum of the changes in the categories in which the information is too difficult to decipher to be informative: ∆OTHER-r,
∆MININT, and ∆SUB-r. ∆NON-BTD is the sum of the changes in categories from the rate reconciliation which pertain to taxes,
rather than to differences between book income and taxable income: ∆ADJTR, ∆AUDIT, ∆CREDITS-r, ∆ETI, ∆FOR-r, ∆REPAT,
and ∆STATERATE. All non-categorical variables are scaled by beginning of year market value of equity.
Table 6
Panel B
∆ NON-BTD
∆ TAX BTD-r
∆ NO
INFO
BTD-r
∆ Permanent
∆ NO
INFO
BTD-t
∆ TAX BTD-t
∆ Temporary
∆ AQ BTD
pred
intercept
∆ PTBI
∆ CTE
∆ NOL_ADJ
∆ ADA
∆ BENEFITS
∆ ENVIRON
∆ EXP
∆ INTANG
∆ INVENT
∆ LEASE
∆ MTM
∆ OPEB
∆ PPE
∆ REV
∆ UNUSUAL-t
∆ VA
∆ WARRANTY
∆ CREDITS-t
∆ FOR-t
∆ M&A-t
∆ NOL
∆ REG-t
∆ STATE
∆ OTHER-t
∆ SUB-t
∆ AMORT-GW
∆ AMORT-OTH
∆ COLI
∆ DIVS
∆ DMD
∆ M&A-r
∆ REG-r
∆ TEI
∆ UNUSUAL-r
∆ MININT
∆ OTHER-r
∆ SUB-r
∆ ADJTR
∆ AUDIT
∆ CREDITS-r
∆ ETI
∆ FOR-r
∆ REPAT
∆ STATERATE
2
(+)
(+)
F
0.144
1.058
1.153
0.165
-0.961
-0.512
0.031
-0.16
0.665
-0.373
-0.53
0.008
-0.06
0.217
-1.095
-0.352
1.197
4.231
-1.028
0.627
-1.424
-0.312
0.112
-0.665
**
**
*
*
0.196
-0.684
-1.169
-3.219
-1.842
0.518
5.668
-0.503
-4.134
7.745
0.528
20.27
2.979
0.988
1.478
-0.377
5.228
1.183
0.423
-3
-0.502
*
Adjusted R
14.80%
** (*) significant at the 0.01 (0.05) level, using a two-tailed test where no sign is predicted
The dependent variable is Rit , which denotes the market-adjusted return for firm i and is defined as the compound (with
dividend) return less the compound return on the value-weighted market portfolio. Returns are calculated over a 16-month
period, starting at the beginning of fiscal year t and ending four months after the end of the fiscal year t. ∆PTBI is the change in
pretax book income less minority interest. ∆TI is the change in taxable income, which is calculated as current tax expense
(federal current plus foreign current where available, total tax expense less deferred tax expense otherwise) divided by the
statutory rate, adjusted for the change in the NOL carryforward reported by Compustat. ∆CTE and ∆NOL_ADJ break ∆TI into its
two components: ∆CTE is the current tax expense, as calculated above, divided by the statutory rate, while ∆NOL_ADJ is the
amount that ∆TI is affected by the change in NOL carryforwards. All non-categorical variables are scaled by beginning of year
market value of equity.
The values for each category formed from accounts in the statement of deferred tax positions are computed as the difference
between the values in year t and year t-1 less the difference between the values in year t-1 and year t-2, stated in dollars of
income. These categories are: BENEFITS: bonus accrual expense; accrued compensation expense; accrued vacation expense;
accrued healthcare expense; employee stock plan expenses; workers compensation expense; other employment benefits; items
that contain combinations of employment benefits, other post-employment benefits, and pensions. CREDITS-t: credit
carryforwards. ENVIRON: asset retirement/abandonment obligation expenses; accrued environmental expenses;
decommissioning reserves/removal costs; depletion expenses; emission allowances; mineral reserves; exploration costs. EXP:
advertising/marketing/promotion expenses; member acquisition costs; policy acquisition costs; loan origination costs; travel
reward program expenses; other expenses. FOR-t: currency translation adjustments; taxes on unremitted profits; deductions
related to foreign subsidiaries; deferred foreign income taxes; foreign inventory adjustments. INTANG: acquired intangible assets
(including goodwill); start-up and organization costs; capitalized research and development; software development costs;
mortgage servicing rights; franchise costs; license costs; research and development write-offs. INVENT: capitalized inventory
under UNICAP; intercompany profit in inventory, inventory valuation adjustments. LEASE: capital lease adjustments by the
lessee; gains from sale-leaseback transactions; lease-related expenditures. M&A-t: acquisition/merger-related costs; gains/losses
on the sale of subsidiaries or business units, restructuring and reorganizational costs; discontinued operations. MTM: unrealized
gains/losses on available-for-sale securities; unrealized gains/losses on non-available-for-sale securities; items that contain both
available-for-sale and not available-for-sale securities; it includes derivative and hedging activities. NOL: net operating loss
carryforwards; capital loss carryforwards; charitable contribution carryforwards. OPEB: pension expenses; other postemployment benefit expenses. OTHER-t: line items too vague to categorize (e.g., “other adjustments”); includes items which are
partially but not fully categorizable (e.g., “accounts receivable and inventory”). PPE: difference between book and tax
depreciation or property; allowance for funds used during construction; asset impairments/write-downs; asset valuation reserves;
assets held for sale; items that contain both depreciation and intangible amortization. REG-t: adjustments unique to regulated
entities; unrecovered gas and fuel costs; unamortized nuclear costs; statutory contingency reserves; rate refunds and rate case
costs; power purchase agreements. REV: accrued dividends and royalties, advance payments; contract accounting differences;
intercompany receivables; customer deposits, customer discounts; unearned revenue; other deferred income/revenue; completed
contract method of accounting; present value of future profits; deferred lease revenue. STATE: state and local franchise and
income taxes; valuation allowances on state deferred taxes. SUB-t: subsidiary, partnership, and joint venture investments; equitymethod subsidiary investments; earnings from partnerships and joint ventures. UNUSUAL-t: all line items not included in another
category. They are material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to
warrant a separate category. VA: change in the valuation allowance. WARRANTY: warranty reserves and accruals.
The values for each category formed from items in the rate reconciliation are computed as the dollar value in the rate
reconciliation in year t less the dollar value in the rate reconciliation in year t-1. These categories are: ADJRET: provision to tax
return adjustments, adjustment of deferred taxes due to changes in rates or laws, change in the valuation allowance. AMORT-GW:
amortization and impairments of goodwill; effect of non-deductible goodwill; negative goodwill amortization; purchase
accounting adjustments. AMORT-OTH: amortization of intangible assets; nondeductible amortization; includes acquired
purchased in-process research and development. AUDIT: audit resolutions and settlements; adjustments of tax reserves or prior
year adjustments; FIN 48 and other tax contingencies. COLI: company-owned life insurance. CREDITS-r: all credits including
state, foreign, investment, and alternative minimum tax; credit carryforwards; expiration of credits. DIVS: non-taxable dividends,
including dividends-received deduction. DMD: domestic production activities deduction. ETI: benefits of FSC and ETI. FOR-r:
effects of foreign rates higher or lower than U.S. statutory rate; currency translation adjustments; foreign tax holidays; foreign
withholding tax. M&A-r: merger costs, Gains/losses on the sale or disposal of subsidiaries, restructuring charges. MININT:
minority interest. OTHER-r: line items too vague to categorize (e.g., “nondeductible expenses”); includes items which are
partially but not fully categorizable (e.g., nondeductible goodwill and other). REG-r: items unique to regulated entities. REPAT:
effects of repatriating foreign income. STATERATE: effects of U.S. state income tax rates. SUB-r: equity earnings in affiliates;
gain on subsidiary IPO; consolidation differences; write-downs of equity investments, permanent items flowed-through from
subsidiaries. TEI: non-taxable interest and dividends. UNUSUAL-r: all line items not included in another category. They are
material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to warrant a separate
category.
46
Table 7
Estimated Regression Coefficients from Regressing 16-month returns on
on pre-tax book income and taxable income or book-tax differences using Generalized Least Squares
Fortune 250 firms, 1994-2007
(n=468)
(n=57)
variable
pred Mining
intercept
-0.354**
∆ PTBI
(+)
1.852*
∆ TI
∆ CTE
(+)
0.863
∆ NOL_ADJ
1.63
∆ Temporary
∆ AQ BTD
∆ BENEFITS
∆ ENVIRON
∆ INTANG
∆ INVENT
-0.556
∆ MTM
∆ OPEB
∆ PPE
0.248
∆ UNUSUAL-t
∆ VA
0.329
∆ TAX BTD-t
∆ CREDITS-t
∆ NOL
-0.955
∆ REG-t
∆ NO INFO BTD-t
∆ OTHER-t
(n=212)
(n=169)
(n=83)
(n=162)
(n=190)
(n=563)
(n=351)
Food
Textile
Chemical
Pharma
Extraction
0.054
-0.217
-0.082**
0.313
0.045
1.844
-0.168*
3.614**
0.249*
1.412**
1.477
0.173
-0.648*
1.251**
0.876
0.238
0.334
-0.429
-1.253
0.035
5.064**
4.238*
0.544
-0.438**
2.144**
-0.075
1.222
0.116
(n=282)
Retail
Banks &
Insurance
Services
0.063
0.490*
-0.348*
0.678
-0.132
0.257
-0.179
0.448
0.396*
0.863*
1.704**
-0.022
1.159**
0.022
1.900
0.276
-0.494
0.217
(n=394)
(n=630)
Utilities
0.041
0.715**
0.197
-0.239
Durables Computers Transport
-0.846**
(n=118)
0.055
0.842*
0.541
1.914
2.068*
-0.145
-0.052
-0.289
0.329
-0.174
0.083
0.007
-0.144*
0.401*
0.445
0.409
0.050
0.057
-0.526
-0.357
0.208
0.120
-0.293
-8.594**
-0.160
-0.824
0.418
-0.217
-0.022
1.138
0.119
0.274
-0.560
0.398*
0.880
0.265*
0.036
0.780
0.383
-0.923*
0.446
0.438
0.253
-0.0243
-0.485
** (*) significant at the 0.01 (0.05) level, using a two-tailed test where no sign is predicted
The dependent variable is Rit , which denotes the market-adjusted return for firm i and is defined as the compound (with dividend) return less the compound return on the valueweighted market portfolio. Returns are calculated over a 16-month period, starting at the beginning of fiscal year t and ending four months after the end of the fiscal year t. ∆PTBI
is the change in pretax book income less minority interest. ∆TI is the change in taxable income, which is calculated as current tax expense (federal current plus foreign current
where available, total tax expense less deferred tax expense otherwise) divided by the statutory rate, adjusted for the change in the NOL carryforward reported by Compustat.
∆CTE and ∆NOL_ADJ break ∆TI into its two components: ∆CTE is the current tax expense, as calculated above, divided by the statutory rate, while ∆NOL_ADJ is the amount that
∆TI is affected by the change in NOL carryforwards. All non-categorical variables are scaled by beginning of year market value of equity.
For each industry, we include the four disaggregated book-tax differences which are both reported by at least 50% of the industry observations and have the highest mean, in
absolute value. The values for each category are formed from accounts in the statement of deferred tax positions and are computed as the difference between the values in year t
and year t-1 less the difference between the values in year t-1 and year t-2, stated in dollars of income. These categories are: BENEFITS: bonus accrual expense; accrued
compensation expense; accrued vacation expense; accrued healthcare expense; employee stock plan expenses; workers compensation expense; other employment benefits; items
that contain combinations of employment benefits, other post-employment benefits, and pensions. CREDITS-t: credit carryforwards. ENVIRON: asset retirement/abandonment
obligation expenses; accrued environmental expenses; decommissioning reserves/removal costs; depletion expenses; emission allowances; mineral reserves; exploration costs.
INTANG: acquired intangible assets (including goodwill); start-up and organization costs; capitalized research and development; software development costs; mortgage servicing
rights; franchise costs; license costs; research and development write-offs. INVENT: capitalized inventory under UNICAP; intercompany profit in inventory, inventory valuation
adjustments. LEASE: capital lease adjustments by the lessee; gains from sale-leaseback transactions; lease-related expenditures. MTM: unrealized gains/losses on available-forsale securities; unrealized gains/losses on non-available-for-sale securities; items that contain both available-for-sale and not available-for-sale securities; it includes derivative and
hedging activities. NOL: net operating loss carryforwards; capital loss carryforwards; charitable contribution carryforwards. OPEB: pension expenses; other post-employment
benefit expenses. OTHER-t: line items too vague to categorize (e.g., “other adjustments”); includes items which are partially but not fully categorizable (e.g., “accounts receivable
and inventory”). PPE: difference between book and tax depreciation or property; allowance for funds used during construction; asset impairments/write-downs; asset valuation
reserves; assets held for sale; items that contain both depreciation and intangible amortization. REG-t: adjustments unique to regulated entities; unrecovered gas and fuel costs;
unamortized nuclear costs; statutory contingency reserves; rate refunds and rate case costs; power purchase agreements. UNUSUAL-t: all line items not included in another
category. They are material enough to warrant separate disclosure for that firm but occur too infrequently in the sample to warrant a separate category. VA: change in the valuation
allowance.
48