Is Tax Return Information Useful to Equity Investors?

Abstract

In this study, I examine whether tax return information is incrementally useful to equity investors relative to publicly-available information, such as financial statements. To test this relation, I exploit unique features of the syndicated loan market, as prior literature shows that lenders obtain tax returns from borrowers and that lenders' private information is transmitted to equity markets when institutional investors are part of a loan syndicate. I find economically significant increases in tax expense valuation and decreases in taxrelated market anomalies following the issuance of institutional syndicated loans, consistent with equity investors finding information about firm performance in tax returns that is useful for their trading decisions. I also document that tax returns are a valuable information source that can motivate institutional investor participation in loan syndicates. This study informs the important, ongoing policy debate over public disclosure of corporate tax return information and extends prior research by showing that investors use information from tax returns incremental to information in financial statements.

Increasing tax transparency: investor reactions to the country-by-country reporting requirement for EU financial institutions

“…Ultimately, this can help to increase the accuracy of analysts' forecasts. Prior evidence suggests that tax-related information can be useful in forecasting future earnings (Hanlon et al, 2005;Bratten et al, 2017;Demere, 2017).…”

Does tax return disclosure affect information asymmetry among investors?

“…My study provides evidence that mandatory tax return disclosure reduces information asymmetry not only at the time of the release (Ball and Shivakumar 2008), but also when additional information is provided in the future (Hail et al 2021). Demere (2018) provides indirect evidence that private tax return information is used in the trading decisions of institutional investors who also participate in the syndicated loan market in the U.S. My study complements this study by directly showing that tax returns can be used by unsophisticated investors, meaning that public disclosure of tax return information is widely useful.…”

“…<insert Figure 1 here> 2.2 Tax transparency and public disclosure Tax returns are used by some investors because they provide decision-useful information beyond financial statements (Cussatt and Demere 2019;Demere 2018). Hoopes et al (2018) and Chen (2017) find a negative market reaction to the ATO's tax-return disclosure for disclosing firms, both at the time of the mandate's announcement and at the time of disclosure.…”

“…In this study, I explore whether tax return disclosure is broadly informative to investors by examining how it affects information asymmetry among more-and less-sophisticated investors. 1 On the one hand, without tax return disclosure, some sophisticated investors are better informed than others and thus have an information advantage-for example, those with higher ability to predict tax-related future cash flows from only the financial statements, 2 or those with access to private tax-related information (Chi et al 2014;Demere 2018). Therefore the new tax disclosure could reduce information asymmetry to the extent that less-informed investors can now process and utilize the information (Diamond 1985;Verrecchia 1982).…”

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

“…Two studies investigate settings where selected investors get access to confidential tax returns. Demeré (2018) exploits the features of the US syndicated loan market, where lenders frequently request tax returns when evaluating bank loan applications. He assumes that when a syndicated loan is traded on secondary markets and the loan syndicate includes institutional investors, the tax return information is disseminated to the equity market and can thus be incorporated into share prices.…”