Do Analysts Fully Understand the Tax Implications of Foreign Operations?

U.S. based multinational firms are able to use foreign subsidiaries as a means to reduce their overall tax burden. As disclosure requirements are vague, there is very little useful information provided to firm outsiders to analyze a firm’s foreign operations activity and earnings. I demonstrate that even sophisticated financial statement users, financial analysts, have difficulty predicting the effective tax rate for firms with foreign operations, as evidenced by increased forecast errors for multinational firms as compared to domestic firms. I examine factors that may contribute to the increased difficulty of forecasting for multinationals and find that decreased ETR persistence and the presence of a loss may affect the difficulty of the forecasting task, but the presence or quality of management forecasts may not. The market finds tax forecasts important as evidenced by the positive response to the tax and non-tax components of earnings forecasts. This evidence is useful to investors, policy makers, and others interested in the tax activities of multinational firms.