Mispricing of book-tax differences and the trading behavior of short sellers and insiders

Sabrina S. Chi, Morton Pincus, Siew Hong Teoh

Research output: Contribution to journalArticle

22 Scopus citations

Abstract

We find evidence that investors misprice information contained in book-tax differences (BTDs), measured as the ratio of taxable income to book income, TI/BI. Low TI/BI predicts worse earnings growth and abnormal stock returns than high TI/BI. We find that short sellers and insiders arbitrage BTD mispricing, but the arbitrage is imperfect because of constraints on short selling and insider trading. Under SFAS No. 109 the predictability is stronger for TEMP/BI, the temporary component of TI/BI, which reflects greater managerial discretion. The results are incremental to a large set of known accruals-based anomaly predictors. We suggest that a sunshine policy of disclosing a reconciliation of book and taxable incomes can reduce mispricing of BTDs and improve capital market resource allocation.

Original languageEnglish
Pages (from-to)511-543
Number of pages33
JournalAccounting Review
Volume89
Issue number2
DOIs
StatePublished - Mar 2014

Keywords

  • Anomalies
  • Arbitrage
  • Book-tax differences
  • Insider trading
  • Market efficiency
  • Mispricing
  • Short selling

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