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Pre-tax Versus After-tax Earnings: Do Appearances Matter?
Leslie A. Robinson,
Tuck School of Business at Dartmouth
ABSTRACT. This paper examines the relative importance to managers of pre-tax and after tax financial accounting earnings. It exploits features of investments in housing tax credits and GAAP accounting for those investments. When managers purchase tax credits, accounting rules reduce earnings for the cost of the tax credits through either i) a pre-tax expense, or ii) a tax expense. I find a price premium on tax credit investments that reduce earnings through tax expense, thereby avoiding a reduction to pre-tax earnings. This result suggests that managers pay for income statement classification by sacrificing after tax earnings to report higher pre-tax earnings. I estimate that these managers pay $1 for higher pre-tax earnings in the range of $13 to $27, on average.
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