An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Anibal Baez - Diaz
University of Puerto Rico

Pervaiz Alam
Kent State University

Abstract: We examine how taxes affect the extent to which the market uses financial information efficiently. A sample of US firms is used to compute discretionary accruals. The evidence shows that during 1986-2001 corporations increased the use of income decreasing discretionary tax accruals to reduce their tax liability without raising the chances of higher scrutiny from IRS. Compared with prior studies, our tests reveal that the persistence of the nondiscretionary book accruals is insignificantly different than the cash flow component of earnings. This implies that tax incentives embedded in tax accruals provide a more transparent measure of book accruals that better reflects changes in earnings and firm value. The Mishkin (1983) model reveals that the market’s perceived persistence of accruals and cash flows differ significantly from their actual persistence. The market’s inability to correctly assess the persistence of accruals is more severe for tax accruals than for book accrua

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