Discussion of : 'Taxable Income as a Performance Measure: The Effects of Tax Planning and Earnings Quality'

Ayers, Jiang and Laplante (2008) provide evidence that the association between taxable income and market returns is a function of the level of noise in taxable income. Their study extends the nascent but growing literature which documents a correlation between taxable income and market returns - a result which holds up in multivariate analyses that properly control for book income (e.g., Hanlon, 2005; Hanlon, Laplante and Shevlin, 2005; Lev and Nissim, 2004; and Shevlin, 2002). Ayers et al. (2008) partition their sample firms based on the extent of tax planning and provide evidence that the noise introduced by this activity weakens the association between taxable income and returns. This result provides a useful contribution to the literature because it strengthens the body of evidence which suggests that taxable income incorporates elements of economic income. The paper also provides evidence which addresses whether the association between taxable income and market returns is a function of the noise in book income. This discussion will focus on three issues: (1) hypothesis development, (2) research design, and (3) directions for future research