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Do Firms Use Tax Cushion Reversals to Meet Earnings Targets?
Sanjay Gupta, Michigan State University
Rick Laux, Arizona State University
ABSTRACT. Using detailed analyses of financial statement disclosures and earnings releases, we examine whether firms use tax cushion reversals to meet or beat earnings benchmarks. For a random sample of 100 Fortune 500 firms during 2003-2005, the mean tax cushion reversal is $0.09 per share, which represents 17% of the mean pre-reversal actual EPS per I/B/E/S and 28% of the mean pre-reversal GAAP-based EPS. Frequency analysis shows strong evidence of firms opportunistically using tax cushion reversals to meet or beat earnings benchmarks. For example, without the tax cushion reversal, 53% of reversal firm-quarter observations meet or beat the analysts’ EPS forecast. After the tax cushion reversal, however, 93% of reversal firm-quarter observations meet or beat analysts’ EPS forecast. Tobit regressions of the tax cushion reversals show that they are significantly increasing in both the frequency and magnitude of the difference between earnings benchmarks and pre-reversal earnings.
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