Tax Expense Surprise and Emerging Market Equity Returns

Abstract

This study investigates the relation between tax expense surprise and expected equity returns in emerging markets. Utilizing a broad sample of equities from 27 emerging countries, we find strongly positive link between tax expense surprise and the cross-sectional expected stock returns. Univariate portfolio analyses in the overall sample show that equities in the highest tax expense surprise quintile earn 8.52% higher risk adjusted annual return than equities in the lowest tax expense surprise quintile. This relation remains robust to alternative definitions of tax expense surprise and even after controlling for other anomalies related to financial and tax variables in a regression framework. We document that tax expense surprise strongly predicts expected stock returns in emerging markets.