Does Tax Planning Affect Analysts' Forecast Accuracy?

Abstract

We investigate whether firms' tax planning affects the accuracy of analysts' forecasts. Tax planning can exacerbate the complexity of firms' operations through strategic choices to exploit tax laws. Because of its effect on firms' operations, tax planning can influence analysts' efforts to understand and forecast earnings. Specifically, if the additional complexity arising from tax planning makes firm attributes less representative of expected earnings, analysts may issue less accurate forecasts. Using auditor‐provided tax services (APTS) as a measure of tax planning, we find that, as firms spend more on tax planning, the accuracy of analysts' forecasts of both earnings per share and tax expense declines. We also document that firms with higher levels of APTS have greater year‐to‐year volatility in, and lower persistence of, effective tax rates and earnings. Our results suggest that increased firm complexity, due to greater tax planning, makes earnings and tax expense more difficult to forecast and that analysts do not properly adjust for these effects. Thus, when deciding to engage in tax planning, firms appear to make trade‐offs between potential tax savings and negative effects on earnings properties and analysts' forecasts.

Does Private Country-by-Country Reporting Improve the Tax and Earnings Information Environment for Investors?

“…However, the information value of tax for capital markets is distorted when MNEs engage in tax planning that separates income from economic activities. Consistently, prior research documents that more tax planning activities are associated with lower tax accrual quality (Choudhary et al, 2016), less accurate analysts' forecasts of tax expenses (Francis et al, 2019), and less value relevant taxable income (Ayers et al, 2009). In addition to the tax information environment, the misalignment between tax and economic activities further complicates business operation because of the complex and opaque organization structures used to achieve distortive tax practices (e.g., Levin and McCain, 2013).…”

Street versus GAAP: Which Effective Tax Rate Is More Informative?*

“…Similarly, Brushwood et al (2019) find that ETR forecast accuracy declines following Accounting Standards Update 2016–19, which changed the accounting rules for the tax effects of stock options. Additional recent evidence suggests that analysts underestimate the persistence of earnings created by changes in ETR (Kim et al 2020) and that they do not accurately forecast the implications of auditor‐provided tax services (Francis et al 2019). Consistent with analysts having difficulty with the complexity involved in ETRs, Hutchens (2017) finds that analysts struggle to forecast ETRs when tax disclosures contain legal jargon or complex words.…”

“…Second, consistent with investors demanding additional tax‐related information, analysts are increasingly providing forecasts of different financial metrics, including tax metrics (Mauler 2019). However, there is substantial debate in the literature about the extent to which analysts incorporate tax information into their analyses (Mauler 2019; Bratten et al 2017; Francis et al 2019). Therefore, examining street ETRs provides insight on the extent to which analysts, a group of sophisticated financial statement users, understand and use tax information.…”

On the Determinants and Effects of Corporate Tax Transparency: Review of an Emerging Literature

“…Against this backdrop, it is surprising that we lack any evidence on whether analysts use the information of new public tax-related disclosures (e.g., public CbCR, public tax return disclosure, tax strategy reports) and on whether the mandated increase in tax transparency affects analyst coverage, forecast accuracy, and forecast dispersion. Moreover, considering the emergence of studies on the relationship between a firm's tax aggressiveness and analyst activity (Allen et al, 2016;Balakrishnan et al, 2019;Francis et al, 2019;He et al, 2020), it would be interesting to examine how changes in tax transparency influence this relation. 69…”