ABSTRACT This study tests the joint prediction of the substitution effect and the tax exhaustion hypothesis that an increase in non‐debt tax shields leads to a decrease in leverage. Controls are introduced for the debt securability effect, the pecking order theory of financing, and the probability of losing tax shields. Using the relationship between changes in investment tax shields and changes in debt tax shields of firms in response to the Economic Recovery Tax Act of 1981, strong empirical support is found for predictions based on the substitution effect and the tax exhaustion hypothesis.

This study tests the joint prediction of the substitution effect and the tax exhaustion hypothesis that an increase in nondebt tax shields leads to a decrease in leverage. Controls are introduced for the debt securability effect, the pecking order theory of financing, and the probability of losing tax shields. Using the relationship between changes in investment tax shields and changes in debt tax shields of firms in response to the Economic Recovery Tax Act of 1981, strong empirical support is found for predictions based on the substitution effect and the tax exhaustion hypothesis.

[Several analytical models of the year-end inventory purchasing decision of a LIFO firm have been developed (Cohen and Halperin 1980; Halperin 1979, 1981; Biddle and Martin 1985).1 This study finds empirical support for the prediction of these models that, since only LIFO firms reduce their tax burden by purchasing additional inventory (i.e., "extra" inventory) at year-end, LIFO firms are more likely to purchase extra inventory at year-end than FIFO firms. This research also provides evidence that high-tax LIFO firms are more likely to purchase extra inventory at year-end than low-tax LIFO firms. This behavior is predicted because a LIFO firm's tax savings from purchasing extra inventory at year-end are increasing in its marginal tax rate. Additional evidence of tax-motivated year-end inventory purchases is offered by tests which find that (1) consistently high-tax LIFO firms accelerated their year-end inventory acquisitions-and thus reduced their taxable income-to a significant degree in the years immediately preceding the reduction in tax rates mandated by the Tax Reform Act of 1986; and (2) differences in tax status are not related to differences in fourth quarter inventory purchasing behavior for FIFO firms. The results of this study indicate that taxes have a sizable effect on the inventory purchasing policy of LIFO firms. For example, (1) the estimated difference in the percentage of annual inventory purchases made in the fourth quarter between high-tax and low-tax LIFO firms is equivalent, on average, to 12.66 million of purchases (3.8 percent of ending inventory); and (2) the estimated decrease in inventory purchases made in the fourth quarter by LIFO firms that move from a high-tax status in one year to a low-tax status in the following year is equivalent, on average, to 28.89 million of purchases (12.1 percent of ending inventory). These large dollar amounts lend credence to the concern that year-end LIFO inventory purchases made for tax purposes may lead to inventory management inefficiencies (Jannis et al. 1980, 186).]

Abstract Examines analytical models of year-end purchasing decisions of a last in, first out (LIFO) firm. Prediction that LIFO firms are more likely to purchase extra inventory at year-end than first in, first out (FIFO) firms; Effect of taxes on the inventory purchasing policy of LIFO firms; Cost of goods sold management.

We find that a firm's dividend yield has a positive impact on its common stock return that is decreasing in the level of institutional and corporate ownership, our indicator of whether the marginal investor in a firm's common stock is more likely to be a low-tax or a high-tax investor. These results suggest that (1) a dividend tax penalty is incorporated into the return on a firm's common stock and (2) both a firm's dividend policy and its ownership structure impact the size of the dividend tax penalty.

LIFO Liquidation, Tax incentives, Debt covenants, Inventory valuation

With the exception of financial firms, we find no evidence that comprehensive income is more strongly associated with returns/market value or better predicts future cash flows/income than net income. Moreover, the only component of comprehensive income that improves the association between income and returns is the marketable securities adjustment. Our results do not support the claim that comprehensive income is a better measure of firm performance than net income. Our results also raise questions about the appropriateness of items included in SFAS 130 comprehensive income as well as the need for mandating uniform comprehensive income disclosures for all industries.

Abstract Guenther and Trombley (1994) and Jennings, Simko, and Thompson (1996) document a negative association between a firm's last‐in, first‐out (LIFO) reserve and the market value of its equity. In this paper, we test a deferred tax explanation of this negative association. Specifically, we argue that investors, conditional on adjusting inventory to as‐if first‐in, first‐out (FIFO), estimate a firm's future LIFO liquidation tax burden as its LIFO reserve multiplied by the appropriate corporate tax rate and include this tax‐adjusted LIFO reserve in the valuation of a LIFO firm's net assets. On the basis of this argument, the tax‐adjusted LIFO reserve is in effect an estimate of an off‐balance‐sheet deferred tax liability and, as a result, we predict a negative association between the tax‐adjusted LIFO reserve and market value of equity. We test our deferred tax explanation by estimating a valuation model in which a firm's market value of equity is expressed as a function of the firm's assets, liabilities, deferred tax liability, and tax‐adjusted LIFO reserve; the model is estimated separately in years preceding and following the reduction of tax rates mandated by the US Tax Reform Act of 1986. Test results provide strong support for the deferred tax explanation of the negative association between a firm's LIFO reserve and the market value of its equity.

We draw on the investor protection literature to identify structural factors in the financial reporting environment that are likely to explain cross-country differences in the information content of annual earnings announcements. Using data from over 50,000 annual earnings announcements in 26 countries, we find that annual earnings announcements are more informative in countries with higher quality earnings or better enforced insider trading laws, and that annual earnings announcements are less informative in countries with more frequent interim financial reporting. We also find that, on average, earnings announcements are more informative in countries with strong investor protection institutions.