Taxable income and firm risk

We examine whether estimated taxable income provides incremental information about firms’ operating risk. We develop taxable income-based measures that should be useful in assessing risk in a simple earnings predictability model. In our empirical tests these taxable income-based measures explain cross-sectional variation in the predictability and variability of future pre-tax financial performance. Further, these measures are associated with predictable variation in market-based measures of firm risk. Our findings shed light on how accounting information-specifically, book income and tax income-impacts investors’ assessment of firm risk as well as improving our understanding of the extent and nature of information contained in estimated taxable income.