Financial Accounting Consequences of Temporary Tax Law: Evidence from the R&D Tax Credit.

Abstract

This paper investigates the extent to which extensions of a temporary tax law reduce market participants’ ability to predict and understand corporate earnings. Examining evidence from eight separate extensions of the R&D tax credit, I find that market participants adjust their expectations for corporate earnings upwards in response to extensions of the R&D tax credit, but doing so incrementally decreases the accuracy of earnings forecasts. The evidence also suggests that abnormal bid-ask spreads around quarterly earnings announcements increase for firms affected by an expired R&D tax credit, suggesting that trading costs rise when markets have difficulty interpreting earnings affected by the expired R&D tax credit. The results of this study call attention to previously unexplored costs of temporary tax laws—capital market confusion related to corporate earnings affected by expired tax laws.