Analyst and Market Responses to Tax Motivated Loss Shifting

We expect firms to increase losses in response to the ability to claim tax refunds for the carryback of tax losses. Results indicate that firms' unexpected losses are increasing in the tax benefit of the carryback of the loss, and this result holds across a number of time periods and tax regimes. We also examine analyst forecast errors to determine if analysts anticipate this tax-motivated loss shifting. Analyst forecast errors are negative for the firms identified as increasing losses in response to the tax carryback incentive consistent with analysts failing to anticipate such tax-motivated loss shifting. Finally, we analyze the stock market reaction to the observed unexpected losses and find no significant reaction to the losses, a result that suggests that equity markets anticipated such tax-motivated income shifting.