Study says that investors can get a clearer idea of tax outcomes if they use 'street' ETRs
When investors or their financial advisors are assessing the merits of investing in a business, they are likely to rely on the company’s financial statements.
But when it comes to tax outcomes, a new study suggests that analysts may provide a better indication than financial reports.
Researchers at Notre Dame University determined that Effective Tax Rates (ETRs) – essentially a company’s tax expense divided by pre-tax income reported in financial statements – are calculated using generally accepted accounting principles (GAAP).
But analysts’ outlooks are likely to be adjusted if they spot an unusual or infrequent item in statements, resulting in a street ETR. An example might be a large tax liability that is not a reflection of the company’s underlying performance.
“Taxes are a significant component of earnings, but the extent to which analysts understand and use tax information is not clear,” said Erik Beardsley, assistant professor of accountancy at the Mendoza School of Business. “We find that they make adjustments to tax information in such a way that improves the informative nature of GAAP ETRs.”
Regulator concern
Street ETRs have attracted the attention of regulators, including the SEC, with concern that they may not give investors an accurate picture of a company’s performance.
But Beardsley, together with co-author of the study - “Street vs. GAAP: Which Effective Tax Rate Is More Informative?” – says that their research found that street ETRs were frequently better at determining tax outcomes than GAAP.
“Street earnings metrics such as street ETRs are becoming more and more common, but regulators like the SEC are concerned that non-GAAP metrics can be misleading to readers of financial statements,” Beardsley said. “Our study should be informative to regulators and users of financial statements because it provides evidence that street ETRs are useful.”
