Separating Information about Cash Flows from Information about Risk in Losses

Li, Bin

doi:10.2139/ssrn.2197550

Cited by 2 publications

(11 citation statements)

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“…Finally, I use the valuation of tax expense as a setting to extend the new and growing literature examining the discount rate implications of accounting information. Such studies focus on the information content of earnings reports as a whole or net income as a summary measure of firm performance (e.g., Callen et al 2009;Li 2015;Penman and Yehuda 2015). My results provide evidence that tax expense, a specific and significant financial statement expense, is correlated with discount rate news.…”

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confidence: 81%

“…I decompose a firm's logged total stock return in excess of the annualized three‐month Treasury bill rate ( Ln_Ret_firm ) into log expected returns ( ExpRet ), log discount rate news ( DRN ), and log cash flow news ( CFN ). I then model each component as a function of contemporaneous pre‐tax earnings changes (Δ PTI ) and tax expense changes (Δ TXT ) and several control variables consistent with Hecht and Vuolteenaho () and Li ():

\begin{matrix} R e t_f i r m_{it} = α & + β_{1} Δ P T I_{it} + β_{2} Δ T X T_{it} + β_{3} B 2 M_{i t - 1} \\ + β_{4} l n M K V A L_{i t - 1} + β_{5} R e t_f i r m_{i t - 1} + ε_{italicit}, \end{matrix}

\begin{matrix} E x p R e t_{i t - 1} = α & + β_{1} Δ P T I_{it} + β_{2} Δ T X T_{it} + β_{3} B 2 M_{i t - 1} \\ + β_{4} l n M K V A L_{i t - 1} + β_{5} R e t_f i r m_{i t - 1} + ε_{it}, \end{matrix}

\begin{matrix} C F N_{it} = α & + β_{1} Δ P T I_{it} + β_{2} Δ T<...> \end{matrix}

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Section: Methodsmentioning

confidence: 99%

“…At the firm level, Hecht and Vuolteenaho (2006) find a positive association between earnings changes and discount rate news, but they neither predict nor formally discuss the result in detail. Li (2015) tests the information content of losses versus profits and finds both larger profits and losses are associated with value-increasing revisions to discount rates. Finally, Ball et al (1993) suggest a positive association between earnings changes and expected returns.…”

Section: Prior Literature and Hypothesis Developmentmentioning

confidence: 99%

“…I decompose a firm's logged total stock return in excess of the annualized three-month Treasury bill rate (Ln_Ret_firm) into log expected returns (ExpRet), log discount rate news (DRN), and log cash flow news (CFN). I then model each component as a function of contemporaneous pre-tax earnings changes (DPTI) and tax expense changes (DTXT) and several control variables consistent with Hecht and Vuolteenaho (2006) and Li (2015):…”

Section: Empirical Specificationmentioning

confidence: 99%

“…See, for example, Callen et al (2006Callen et al ( , 2009, Hecht and Vuolteenaho (2006), and Li (2015).…”

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confidence: 99%

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The Information Content of Tax Expense: A Discount Rate Explanation

Henry

2018

Contemporary Accting Res

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I investigate the information content of income tax expense using variance decomposition to separate stock returns into cash flow and discount rate news components. While prior literature has focused on linking tax expense with expected future cash flows, I argue that tax expense should also be informative about discount rates because of its ability to summarize fundamental economic performance. Consistent with my arguments, I find that tax expense surprises are correlated with both revisions in future cash flows and revisions in discount rates; however, the economic magnitude of tax expense's impact on returns is primarily through the discount rate channel. I also perform cross‐sectional tests, which reveal that the discount rate implications of tax expense are due not only to its ability to capture fundamental economic performance but also to its ability to convey information about a firm's earnings management and tax avoidance activities.

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confidence: 81%