The Effect of Temporary Tax Laws on Understanding and Predicting Corporate Earnings

Abstract

This paper investigates the extent to which expirations of a temporary tax law reduce the ability of market participants to predict and understand corporate earnings. Examining evidence from eight separate expirations of the R&D tax credit, I find that analysts’ forecast errors, abnormal bid-ask spreads and abnormal volume increase surrounding quarterly earnings announcements for firms that are affected by the R&D tax credit. These increases suggest difficulties in interpreting earnings that are affected by the expired R&D tax credit. Further, I find that analyst revisions just following extensions of the R&D tax credit are relatively less accurate than other revisions. The results of this study call attention to previously unexplored costs of temporary tax laws, namely, capital market confusion related to corporate earnings affected by expired tax laws.