Forecasting Profitability, Earnings, and Corporate Taxes: Evidence from UK Companies

Saeed Ahmed ()
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Saeed Ahmed: State Bank of Pakistan

No 16, SBP Working Paper Series from State Bank of Pakistan, Research Department

Abstract: This paper follows the Fama-MacBeth (1973) methodology to test the hypothesis that, under competition, profitability reverts to its mean and that, like profitability, earnings are also predictable. The predictability of earnings is then used to estimate changes in corporate taxes from one year to another. The evidence from nearly 13,000 listed and non-listed UK firms supports the extant view that changes in profitability and earnings are predictable. We provide separate estimates for three industrial sectors. In a simple partial adjustment model, we find that profitability of UK companies reverts towards the firm specific mean at a rate of 19% per year for firms engaged in computer consultancy, 24% for hotels and restaurants, and 27% for the transport manufacturing sectors. Thus, the intensity of intra-industry competition and the industry characteristics may be important in explaining differences in the rates of mean reversion across industrial sectors. There are, however, no significant differences in the patterns of mean reversion across sectors. The study further shows that the predictable variation in earnings is attributable mainly to mean reversion in profitability. We find that changes in corporate taxes follow an autoregressive process and that changes in taxes are driven by changes in earnings. We thus show that the notion of mean reversion of profitability is a useful one for forecasting taxes as well as earnings. Length: 34 pages

Keywords: Forecasting; profitability; earnings; corporate taxes (search for similar items in EconPapers)
JEL-codes: G12 H25 (search for similar items in EconPapers)
Date: 2007-05
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