The Market Perception of Book-Tax Differences

Abstract

This paper investigates whether the information impounded in BTD can be used to evaluate firms' future performance and explain firms' equity. Using the Chinese data, I find that BTD is negatively related to one-year-ahead earnings, indicating that BTD is useful for predicting firms' future performance. To determine which information contributes to the predictability of BTD, I decompose BTD into normal and abnormal components as in Tang (2005). The evidence shows that this decomposition provides incremental information to investors. The larger (smaller) NBTD/ABTD signify that the current earnings are more (less) transitory and less (more) persistent, thereby informing on poorer (better) performance in future years. The evidence also shows that the predictive power of NBTD (ABTD) is stronger (weaker) than that of earnings. Further, BTD and its components are incrementally value relevant over current-year earnings. On average, BTD adds approximately 44% to the explanatory power with respect to contemporaneous stock returns.