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Credit Ratings and Taxes: The Effect of Book/Tax Differences on Ratings Changes
Benjamin C. Ayers, University of Georgia
Stacie K. Laplante, University of Georgia
Sean T. McGuire, University of Georgia
ABSTRACT. This paper examines whether credit analysts utilize the information contained in book-tax differences in analyzing a firm’s credit risk. Increased book-tax differences may signal decreased earnings quality or changes in the firm’s off-balance sheet financing. Results suggest a significant positive association between positive changes in book-tax differences and ratings downgrades which is consistent with large positive changes in book-tax differences signaling decreased earnings quality and/or increased off-balance sheet financing. We also find that the association between changes in book-tax differences and rating changes is attenuated when book-tax differences more likely reflect tax planning than decreased earning quality. Collectively, these results suggests that credit analysts not only use the information in book-tax differences in setting ratings, but that they are able to “look through” to the source of the book-tax difference when determining a firm’s credit worthiness.
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