Analysts' Interpretation of Transitory Earnings Components: Evidence from Forecast Revisions after Disclosure of the 1993 Deferred Tax Adjustment

Abstract

This study examines analyst forecast revisions after the disclosure of firms' deferred tax adjustments following the U.S. Omnibus Budget Reconciliation Act of 1993 (OBRA), which raised the corporate income tax rate from 34 percent to 35 percent. This deferred tax adjustment was a one-time item, and should have had no effect on analyst estimates of future earnings. However, we find that forecast revisions issued after the disclosure of an income-decreasing deferred tax adjustment were positively related to the amount of the adjustment. The complexity of the deferred tax adjustment and the newness of SFAS 109 (which required the adjustment) may have contributed to the failure of analysts to properly interpret this one-time item when revising their earnings forecasts.

The Market Response to Beating After‐tax Earnings Targets Revisited using Analysts’ Pre‐tax Earnings Forecasts and Concurrent Tax Note Disclosures

“…However, for our study the relevance was contextual (i.e., only for "achieve pre-tax" firms). This finding contrasts with prior research suggesting that the complexity of tax notes and their distance from the more prominent financial statements has led to their implications being ignored by even sophisticated financial statement users (e.g., Plumlee, 2003;Chen et al, 2003;Weber, 2009;Raedy et al, 2011). An opportunity for future research on the usefulness of the tax note to investors lies in identifying other contexts in which components of tax notes are incrementally informative to the market.…”

“…Similarly, Chen et al. () reveal that analysts do not appear to fully understand particular aspects of tax legislation. They show that a non‐recurring adjustment of US corporate tax rates from 34% to 35% is treated as recurring by analysts who subsequently adjust their earnings forecasts.…”

“…Thus, the costs of processing the complex tax note information is likely to outweigh the benefits of any additional information contained within. Similarly, Chen et al (2003) reveal that analysts do not appear to fully understand particular aspects of tax legislation. They show that a non-recurring adjustment of US corporate tax rates from 34% to 35% is treated as recurring by analysts who subsequently adjust their earnings forecasts.…”

Research in accounting for income taxes

“…We can identify seven directions for further study. First, it is puzzling that the tax information in the financial statements can (apparently) simultaneously communicate so little about a firm's actual taxes (as asserted by many accountants, auditors, 59 In a separate study, Chen et al (2003) find evidence that they interpret as indicating that analysts do not fully understand certain AFIT provisions.…”

Research in Accounting for Income Taxes

“…In a separate study,Chen et al (2003) find evidence that they interpret as indicating that analysts do not fully understand certain AFIT provisions. A one-time deferred tax adjustment was required in association with the 1993 increase in corporate income tax rates from 34% to 35%.…”