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Tax Income Momentum
Jacob K Thomas, Yale School of Management
Frank X Zhang, Yale School of Management
ABSTRACT. Prior research shows that earnings surprises predict future price movements. In this paper we document that similar results are observed when we substitute tax earnings for the book earnings considered in prior research. We confirm that this anomalous link between future returns and tax income surprises is separate from the book income surprise anomaly as well as from other anomalies documented in the prior literature, such as size, book-to-market, accruals, and price momentum. Our analysis suggests that the ability of tax income to predict next quarter’s returns is due partly to its ability to predict next quarter’s book income, which is consistent with the view that the greater discretion associated with computing book income hampers its ability to predict future book income. Our analysis also suggests that tax income appears to predict value-relevant information that is released next quarter, but not included in next quarter’s book income.
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