The market reaction to the forgiveness of deferred taxes due to the repeal of the domestic international sales corporation: expectations regarding subsequent export related tax incentives

International Journal of Business Research, Jan, 2008 by Sid Howard Credle, Sharad Maheshwari, Jacob Angima

PERIOD III--"FIRM-SPECIFIC EARNINGS REPORTS"

31. The firm-specific announcements of corporate earnings the dates of which vary.

The announcement and method effect null hypotheses H(1) & H(2) are as follows:

Hypothesis (1): DISC firm common stocks exhibit no abnormal price
                movements during periods in which information
                concerning DISC policy changes, tax forgiveness issues,
                FSC provisions, and the DISC related earnings
                disclosures are distributed to the market.

Hypothesis (2): During periods in which information concerning DISC
                policy changes, tax forgiveness issues, FSC provisions,
                and the DISC related earnings disclosures are
                distributed to the market, the abnormal price movement
                of common stocks of firms that provided deferred taxes
                do not differ from those of non-providing firms.

If the DISC policy changes have an impact on the future cash flows of DISC exporters, and if the market impounds information quickly into security prices, then the economic effect of the policy changes would be impounded into security prices surrounding the dates when new information arrives. Conceptually, if the information content of an announcement has economic substance to DISC investors, an observed abnormal return should be non-zero. This implies that the market is capable of understanding the economic impact of new information despite different accounting reporting methods. During the tax disclosure period there are two information items that may result in value adjustments. The first is attributable to information distributed regarding the forgiveness of taxes and the second is the effect of distributed information regarding the FSC replacement.

Tax forgiveness could represent "good news" to all firms, on the other hand, the new FSC foreign processes requirements, increases the cost of doing business abroad and represents "bad news" to exporters. If we net the tax forgiveness and the new FSC cost, the response by investors of DISC exporters can be of three possible outcomes during the Tax Deliberations Period. If the future cash benefits from tax forgiveness are greater than the future cost of changing to the new FSC, a positive announcement effect should result, and H(1) would be rejected ceteris paribus. H(2) would also be rejected if investor disentangled firm tax provisions to isolate the accounting method use, since non-providers would not benefit from deferred tax reversals. If the future cost of the new FSC is weighted greater than the benefit of tax forgiveness, a negative abnormal return should result. Again, H(1) would be rejected, and H(2) would be rejected if disentanglement occurred since non-providers would not have forgiveness earnings to offset the FSC cost. The outcome would be neutral if tax forgiveness and FSC cost adjustments were offsetting effects.

Returns during firm-specific disclosures should be linked to the outcomes noted during the FASB deliberations period. If investors made value adjustments with respect to the potential earnings impact of TB 84-2 based on estimates of DISC taxes forgiven or cost to implement the FSC, then during the disclosure period we could observe adjustments to reconcile estimates of DISC earnings to actual forgiveness earnings effects. H(1) would be rejected for providing firms to the extent that actual tax reversals (i.e. additional earnings) exceeded expected earnings attributable to the DISC. If the condition of H(1) rejection holds, it would follow that H(2) would also be rejected since there is no effect due to tax reversals for non-providing firms.