This paper presents an experiment that examines the effect of pro forma earnings disclosures on the judgments of analysts (i.e., more sophisticated investors) and nonprofessional (i.e., less sophisticated) investors. In the experiment, participants developed stock price assessments after reviewing background financial information and a current earnings announcement for a company. The earnings announcement was manipulated to report only GAAP earnings in one condition and both pro forma and GAAP earnings in the other condition. Consistent with empirical evidence, the pro forma earnings in our experiment exceeded GAAP earnings. The results indicate that nonprofessional investors who received an earnings announcement that contained both pro forma and GAAP disclosures assessed a higher stock price than did nonprofessionals who received an announcement containing only GAAP disclosures. Financial analysts' stock price judgments were not affected by the pro forma disclosures. Followup analyses suggest that analysts and nonprofessional investors used different valuation models and information processing. Analysts used well-defined valuation models, based on either earnings-multiples or cash flows, while the nonprofessional investors were more likely to use simpler, heuristic-based valuation models. The pro forma disclosure did not cause nonprofessional investors to assess a higher earnings number for determining a stock price, but rather caused nonprofessionals to perceive the earnings announcement as more favorable, which in turn caused them to convert earnings or some other performance metric into a higher stock price. This effect appears to be due to unintentional cognitive effects, rather than nonprofessionals relying on pro forma earnings information because they perceived it to be informative.

This study investigates the effect of shareholder capital gains taxes on the structure of corporate acquisitions. We analyze a sample of large publicly traded firms acquired in taxable cash-for-stock and tax-free stock-for-stock acquisitions from 1975 to 2000. We model acquisition structure (i.e., taxable cash-for-stock acquisitions versus tax-free stock-for-stock acquisitions) as a function of target shareholder capital gains taxes and other economic factors believed to influence acquisition structure. Consistent with expectations, we find a positive association between the capital gains tax rate for individual investors and the use of tax-free stock-for-stock acquisitions. In addition, we find that the effect of the capital gains tax rate for individuals decreases with target institutional ownership (a proxy that represents the likelihood the price-setting shareholder is not subject to the individual capital gains tax rate). We reconcile our analyses with previous studies and identify a plausible explanation for the lack of results in prior research. In supplemental analysis, we also report evidence that corporations “time” the completion of taxable acquisitions around major tax rate changes to minimize shareholder capital gains taxes. In sum, results suggest that shareholder-level taxes have a significant effect on the choice of taxable cash-for-stock versus tax-free stock-for-stock acquisitions, and this effect varies with the tax status of target shareholders.

We examine whether U.K. managers use the flexibility provided under the partial method for deferred taxes to measure unrecognized deferred taxes opportunistically. We first test whether firm-specific operational and opportunistic factors are associated with the level of unrecognized deferred taxes. The tests provide evidence certain U.K. managers opportunistically measure deferred taxes to manage leverage, consistent with arguments by commentators that deferred taxes heavily influence leverage indicators that play a prominent role in the U.K. contracting framework. Because the proper identification and measurement of both operational and opportunistic determinants of unrecognized deferred taxes influence our tests, we additionally investigate whether unrecognized taxes relate to future deferred tax reversals and future operating profitability of the firm. These tests show the components of deferred taxes predict both future deferred tax reversals and indicators of future profitability of the firm as predicted. Taken together, our results indicate that, on average, the existence of balance sheet management does not nullify the predictive power of (unrecognized) deferred taxes for future deferred tax reversals and for profitability measures. One implication of the results is that the recent U.K. standard change eliminating the partial provision method for deferred taxes potentially has reduced the usefulness of deferred tax disclosures.