Credit Ratings and Taxes: The Effect of Book–Tax Differences on Ratings Changes*
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This paper examines whether credit analysts utilize the information contained in the difference between book and taxable income in analyzing a firms credit risk. Increased booktax differences may be informative for credit rating agencies as they may signal decreased earnings quality or changes in the firms offbalance sheet financing. Results suggest a significant negative association between positive changes in booktax differences and ratings changes. This evidence is consistent with large positive changes in booktax differences signaling decreased earnings quality and/or increased offbalance sheet financing. We also find that large negative changes in booktax differences result in less favorable rating changes, consistent with these changes signaling decreased earnings quality. In additional analyses, we find that the association between changes in booktax differences and rating changes is attenuated for hightax-planning firms (e.g., where booktax differences more likely reflect tax planning than decreased earnings quality). © 2010 CAAA.
author list (cited authors)
AYERS, B. C., LAPLANTE, S. K., & MCGUIRE, S. T.