Income Tax Expense and Value Relevance of Selected African Listed Firms

doi:10.21203/rs.3.rs-5209103/v1

This study examined the effect of income tax accounting on value relevance of selected African listed firms. Concern has emerged that income tax accounting practices might impair the decision-usefulness of financial statements, leading to ineffective resource allocation, diminished investor confidence, and reduced market efficiency. The study adopted an ex-post facto research design and utilized secondary data from the annual reports of 528 firms listed in South Africa, Nigeria, and Kenya, applying multiple regression analysis. The findings revealed that current period tax expense (CPTE) was statistically insignificant in relation to value relevance (VR), with a coefficient of -0.0261, a t-value of -1.61, and a p-value of 0.109 (insignificant at the 5% level). However, prior periods' tax expense (PPTE) had a statistically significant negative effect on VR, with a coefficient of -0.000000907, a t-value of -2.82, and a p- value of 0.005 (significant at the 1% level). Based on these findings, the study recommended that policymakers enforce standardized tax-related disclosures across African countries to enhance financial transparency and comparability. Regulatory bodies were urged to mandate detailed reporting on income tax expenses to improve the decision-usefulness of financial statements.

Accounting

Equity stock return

Income tax expenses

Share price

Value relevance.

One of the stock market indices that informs investors about the caliber of financial information provided to them so they may make wise judgments is the value relevance of accounting data. According to Sixpence et al. (2021), an equity investor's assessment of a company's worth is based on how much information they can obtain about the operating performance of that specific company. Financial statements are a primary source of information about a company's performance for most investors. According to Delegkos et al. (2022), the accounting amount must be expected to be correlated with the equity market value in order to qualify as value relevant. Furthermore, non-accounting measures, which enclose information that has an impact on the equity value can be characterized as value relevance. Value relevance implies the power of financial information to explain stock market variables as contained in financial statements. Stock market measures such as share price, the book value of equity, firm size, cash flow, and earnings guide investors in the pricing of company’s share.

Value relevance refers to the ability of financial information to reflect a company's true economic value or worth. It measures the extent to which financial statements, such as income statements and balance sheets, provide useful information to investors and analysts in assessing a company's value. Dedyansyah and Ulfa (2023) value relevance is often used to evaluate the quality of financial reporting and the usefulness of financial information in capital markets. Financial information is considered value-relevant if it; reflects the company's underlying economic performance, helps predict future cash flows or earnings, provides insights into the company's risk profile, facilitates comparisons with other companies and influences investment decisions. Additionally, it is significant because it promotes efficient capital markets, boosts investor trust, improves capital allocation choices, encourages high-quality financial reporting, and aids regulators and standard-setters in assessing the efficacy of financial reporting laws.

The amount of income taxes that a business must pay on its profits is known as its income tax expense (Nurfadila & Muslim 2021). It is a necessary expense for conducting business and is typically shown as a non-operating item on the income statement. It is computed by multiplying the taxable income of the business by the relevant tax rate(s). Accordingly, the tax rate may change based on the jurisdiction, the nature of the income, and other variables, according to Agrawal and Wildasin (2020). It has an impact on cash flow, EPS, net income, and financial ratios and indicators, among other things, making it significant. For clear financial reporting and adherence to tax rules and regulations, accurate accounting for income tax expense is necessary.

The portion of earnings that are subject to taxation is known as taxable income. It includes various types of investment income in addition to wages, salaries, commissions, and other forms of payment. You can determine how much income tax you must pay after determining your taxable income. Transparency and compliance for firms depend on accurately disclosing income tax expenses in financial statements (Firmansyah et al., 2022). Accurately recording income tax obligations and expenditures in financial reports, such as the balance sheet and income statement, is part of this. Businesses typically record income tax expenses as "Income Tax Expense" or "Provision for Income Taxes" on the income statement. The amount of income tax due for the reporting period is shown here. Businesses also need to include any deferred tax liabilities or assets on their balance sheets. These are transient differences between some assets and liabilities' book value and tax value that could have an impact on future income tax bills (Machdar, 2022).

Because it empowers analysts and investors to make knowledgeable decisions regarding a company's financial performance and prospects, value relevance is significant to income tax expenses. By revealing a company's tax strategy, risks, and uncertainties, it also promotes transparency. Businesses give stakeholders a more accurate and thorough picture of their financial situation and performance by making sure income tax expenses are value-relevant.

2.1 Conceptual Review

2.1.1 Income Tax Expenses

The total amount included in calculating the period's profit or loss with regard to current and deferred taxes is known as tax expense (or tax income). Financial reporting from African businesses includes a significant amount of tax expense. However, variables like intricate tax laws, ambiguous regulations, and fluctuating economic conditions regularly alter its significance. African companies face unique challenges in handling this complexity, which impacts their tax preparation and reporting procedures. Because it empowers analysts and investors to make knowledgeable decisions regarding a company's financial performance and prospects, value relevance is significant to income tax expenses. By revealing a company's tax strategy, risks, and uncertainties, it also promotes transparency. Businesses give stakeholders a more accurate and thorough picture of their financial situation and performance by making sure income tax expenses are value-relevant.

The possibility of tax breaks and incentives is another factor that raises the value relevance of tax expenditure in African nations. In order to encourage investment, economic expansion, and the creation of jobs, several African countries provide tax breaks (Suciarti et al., 2020). A company's ability to make strategic decisions and perform financially can both be strongly impacted by these incentives. Moreover, authorities, lenders, and investors all keep a careful eye on tax expenses (Rachmany & Perpajakan, 2022). The accuracy and consistency of tax expense statistics are critical in African nations where financial reporting is held in high regard and trust. In order to evaluate a company's financial standing, possible hazards, and tax compliance, stakeholders rely on this information. Stakeholders can see a company's financial status, performance, and tax compliance holistically when they comprehend the value significance of tax expense in African businesses (Soliman & Ali, 2020). It facilitates increased openness, better financial analysis, and better decision-making.

2.1.2 Firm’s Value Relevance

One indicator of the quality of financial information provided to investors so they may make educated judgments is the value relevance of accounting data, which is a stock market indicator. The relationship between accounting amounts and securities market values is known as value relevance, and it describes the capacity of accounting data to affect investors' assessments of an entity's potential for future profitability (Odo, 2018). For the accounting amount to be considered value-relevant, it must be expected to be correlated with the equity market value. Moreover, non-accounting measurements that contain data that affects equity value may be classified as having value relevance (Delegkos et al., 2022).

The ability of financial data to explain stock market factors as reported in financial statements is implied by value relevance. Share price, book value of equity, firm size, cash flow, and earnings are examples of stock market metrics that help investors choose how much to pay for a company's shares. Thus, it is imperative that pertinent accounting statistics be fully and transparently disclosed in a financial statement that is meaningful to investors. As a result, IAS 12 income was created to give stakeholders access to value-relevant data that would support them in making business-related financial choices (Dunham & Grandstaff, 2022). When an investor's decision is greatly impacted by other crucial information or by a substantial portion of the firm's equity value, accounting information is considered to be value-relevant (Imhanzenobe, 2022). As a result, the effectiveness with which financial information can influence investors' decisions regarding important investment issues is primarily dependent upon its relevancy.

2.1.3 Impact of Tax Expense on Firm’s Performance

The financial performance of African businesses is significantly impacted by tax expenses (Anwar, 2023). These aspects of accounting have an impact on cash flows, profitability, and overall financial stability. A company's reported profits are directly impacted by its tax expense. While fewer tax expenses result in higher reported earnings, higher tax expenses have the opposite effect. To minimize tax expenses and increase profitability, African businesses must properly manage their tax status (Adegbite & Azeez, 2022). African businesses and stakeholders are better equipped to evaluate cash flows, accurately measure profitability, and make well-informed investment decisions when they comprehend the influence of tax expense on financial performance. In order to maximize financial success, it emphasizes the significance of financial research, tax planning, and strategic decision-making (Görlitz & Dobler, 2023). Additionally, tax expense has an impact on cash flows because lower tax expenses lead to higher cash flows and higher tax expenses result in reduced cash flows.

2.2 Theoretical Underpinning

The framework for this study is Stakeholder Theory, which was first proposed by Freeman in 1984. Stakeholder theory is a perspective on capitalism that emphasizes the interconnected relationships that exist between a company and its suppliers, customers, workers, investors, governments, communities, and other stakeholders. According to the theory, a company should provide value for its owners as well as for all other stakeholders. The foundation of the stakeholder theory is the idea that management ought to act in a way that prioritizes the needs and goals of every group inside the company (Freeman et al., 2021). According to stakeholder theory, a "firm" will consider the interests of its larger stakeholders in order to maximize organizational potential (Kraal et al., 2015). The foundation of stakeholder theory is the idea that companies can only be deemed successful if they provide value to most of its stakeholders. In relation to this study, stakeholders such as investors base their choices on data obtained from financial statements.

2.3 Empirical Review

Prior study was primarily conducted outside of Africa and did not focus on how income tax expenses affect the relevance of values in various contexts. Ostad and Mella (2023) investigate whether partisanship affects the informativeness of business tax expenses and their value significance in an international context. The study conducted cross-sectional analysis, which revealed that while corporation tax expense does not convey information regarding returns when left-leaning parties are in office, it is value-relevant during the administration of right-leaning governments. The study looked into the connections in ten industrialized nations with parliamentary systems as a sample. The sample is made up specifically of G12 nations. It was discovered that, in a global context, corporate tax expenditures are important to investors in right-wing governments and that two possible mechanisms—risk-based impacts and cash flow—can be used to explain how they affect stock returns. The study focuses on African countries, the majority of which are developing countries, because it is based on business tax expenses and investigates developed countries

Abdulla and Zakaria (2022) examined the modernisation of value-added tax relative to how the economies of developed countries in Europe and Latin American countries rely heavily on it, and thus it is a critical component of the tax system for both developing and transforming economies, where modern methods in tax legislation tend towards transferring the tax burden from the sectors of wealth production to the sectors of their use, i.e. The tax is levied on most transactions involving products and services, with the exception of those permitted by the Federal Tax Authority, and the burden is borne by the customer. As a result, a minor increase in the cost of living is to be expected, albeit this varies depending on an individual's lifestyle and spending habits. Only firms with revenues that above the revenue threshold will be required to register for the tax. The report proposed the following recommendations: Preparing enough human resources to carry out the responsibilities of administering the value-added tax and its calculations. In addition, accounting institutions and university departments focused on accounting and tax concepts will be established to localise these professions. The Federal Authority has created offices or permanent branches in government sites such as local economic departments known to merchants to deliver its advice services directly and personally, in order to promote modest initiatives and avoid fines. The study was carried out in Europe and Latin American countries why this study will be carried out in African countries.

Research has demonstrated the importance of income taxes, supporting the claim made by Akinadewo et al. (2023) that taxes are crucial to a nation's ability to maintain its long-term financial stability. Nevertheless, the conceptualization of income tax expenses has not received enough attention in the literature on value relevance that is now available. The majority of published works discussed tax evasion and planning. According to Kołodziej et al. (2023), a taxpayer's choice to comply with tax laws or avoid them was based on their response to the tax authority's notification of the amount of taxes owed. Furthermore, there are few studies that explicitly look into how income tax charges affect the relevance of value in African listed companies.

2.5 Conceptual Framework

Figure 1 depicts a conceptual framework that illustrates the connection between the independent variables, which represent income tax expenses, and the dependent variables (value relevance).

Table 1: Measurement of Variables

3.1 Research Design

Ex-post facto design was used in the investigation. Ex post facto study, often known as after-the-fact research, is a type of research strategy in which scientists examine financial statements that have already been released.

3.2 Population of the Study

The population for the study consisted of 574 listed firms in the selected countries. The study selected the best-performing country from each of three African regions (South African for Southern Africa, Kenya for Eastern Africa, and Nigeria for Western Africa) based on market capitalization.

Table 3.1: Population and Sample Size of the Firms adopted for the Study

Countries	Market Capitalisation by $B	No of Firms (Population)	Sample Size
South Africa	987.24b	354	325
Nigeria	49.56b	155	146
Kenya	9.57b	65	57
Total		574	528

Source: Author’s Tabulation

3.3 Sample Size and Technique

A census sampling technique was employed to determine the sample size from the population, based on the available data in MachameRatios DataPc. Listed firms from the best-performing country in each of the three African regions—Kenya, South Africa, and Nigeria—based on market capitalization were selected for the study, as outlined in Table 3.1.

3.6 Model Specifications

The model's specifications were influenced by a study conducted by Ezejiofor and Aigienohuwa (2023), which examined the value relevance of accounting information and share price in Nigerian manufacturing companies. Their research analyzed the impact of value relevance of accounting information on the share prices of these companies. Using the ordinary least squares (OLS) estimation method, the study covered a ten-year period from 2012 to 2021 and employed E-view 9.0 software for data analysis. The model, adapted for the current research, revealed a positive yet insignificant relationship between stock dividends, earnings per share, and stock price within the manufacturing sector in Nigeria is:

SHPit = β₀ + β₁EPS_it + ε_it

SHPit = β₀ + β₂DPS_it + ε_it

Where:

SHP_it= share price for firm i at the end of year t;

EPS_it = earnings per share for firm i at the end of year t;

DPS_it = dividend per share for firm i at the end of year t;

Є = error term (part of the share price which is not interpreted by the model);

β_0-β₂= the coefficient of explanatory variables.

To investigate the effect of income tax expense on the value relevance of African listed firms.

Y = f (CPTE, PPTE) ………………………….Equation 1

SP = β₀ + β₁CPTE + β₂PPTE + ε Model 3. 1

EST = β₀ + β₁CPTE + β₂PPTE +ε Model 3.2

VR = β₀ + β₁CPTE + β₂PPTE + ε Model 3.3

Where:

SP = The probability of changes in Share Price

EST = The probability of changes in Equity Stock Return

VR = Value Relevance

β₀ = Constant

β₁ - β₂ = Coefficients of the independent variables

CPTE = Current Period Tax Expenses

PPTE = Prior Periods Tax Expense

ε = Error term

This chapter details the results and discusses the findings of the study. This was obtained from the regression results of each objective.

4.1 The Effect of Income Tax Expense on the Value Relevance of African Listed Firms

4.1.1 Descriptive Statistics

This section presents a detailed descriptive statistics analysis for the dependent and independent variables. The statistics include mean, median, minimum, maximum, standard deviation, and coefficient of variation.

Table 4.1

*Descriptive Statistics*
Variables	Obs	Mean	Std. Dev.	Min	Max
VR	5,369	15.71339	99.05707	-2892.113	1746.319
SP	5,369	44.39131	157.6492	0	3451
EST	5,369	-12.96453	114.0866	-5790.625	100
CPTE	5,369	− .1609105	10.7988	-791.2613	.5519198
PPTE	5,369	− .1902185	13.34899	-977.9397	18.76527
Source: Author’s Tabulation (2024)

The descriptive statistics in Table 4.1 provide insights into the central tendencies, variability, and overall distribution of key financial variables relevant to assessing the impact of income taxes (IAS 12) and transfer pricing on the value relevance of selected African-listed firms. The variables examined include Value Relevance (VR), Share Price (SP), Equity Stock Return (EST), Current Period Tax Expenses (CPTE), and Prior Periods Tax Expense (PPTE). Starting with Value Relevance (VR), the mean value stands at 15.71, indicating a relatively low average relevance among the listed firms, with a large standard deviation of 99.06. This high variability suggests significant differences across the firms, with the extreme minimum of -2,892.11 suggesting some firms have severely negative value relevance, perhaps reflecting unfavorable market conditions or firm-specific challenges. The maximum value of 1,746.32 indicates that a few firms have very high value relevance, contributing to a skewed distribution.

The Share Price (SP) variable has a mean of 44.39, with a standard deviation of 157.65, highlighting considerable dispersion in the share prices of the firms under study. The minimum value of 0 suggests that some firms are trading at extremely low or even negligible prices, while the maximum of 3,451 suggests that a few firms have very high valuations, likely influencing the overall spread and leading to significant skewness. Moving on to Equity Stock Return (EST), the mean return is -12.96, indicating that on average, firms experience a negative return, which may be indicative of broader economic or sector-specific challenges. The large standard deviation of 114.09 points to considerable fluctuation in returns among firms, with the minimum of -5,790.63 demonstrating that some firms face exceptionally poor returns, while others achieve better results, though capped at a maximum of 100.

The Current Period Tax Expenses (CPTE) have a mean of -0.16, suggesting that, on average, firms incur minimal current period tax expenses. However, the standard deviation of 10.80 indicates substantial variability, with some firms facing significantly high tax burdens, as reflected in the minimum value of -791.26 and a relatively modest maximum value of 0.55. This negative mean and wide range imply that many firms could be incurring tax losses or facing tax liabilities. The Prior Period Tax Expense (PPTE) similarly has a mean of -0.19, with a standard deviation of 13.35. The minimum value of -977.94 shows that some firms have significant negative tax expenses, potentially due to adjustments or recoveries, while the maximum of 18.77 indicates a wide disparity in tax treatments across different firms.

4.1.2 Pairwise Correlations

Table 4.2 presents the pairwise correlations between the key variables in the study, namely Value Relevance (VR), Share Price (SP), Equity Stock Return (EST), Current Period Tax Expenses (CPTE), and Prior Period Tax Expense (PPTE). The correlation analysis provides insight into the strength and direction of the relationships between these variables, helping to understand the interplay between firm value measures and tax-related metrics.

Table 4.2

Pairwise correlations
Variables	VR	SP	EST	CPTE	PPTE
VR	1.000
SP	0.8178	1.0000
EST	0.8064	0.0384	1.0000
CPTE	0.0011	0.0034	-0.0028	1.0000
PPTE	0.0012	0.0034	-0.0027	-0.0003	1.000
Source: Author’s Tabulation (2024)

The correlation between VR and SP is strong and positive (0.8178), suggesting that as the share price increases, the value relevance of firms also tends to increase significantly. This indicates a close relationship between market valuation and the perceived value relevance of the firm. Similarly, VR also has a strong positive correlation with EST (0.8064), which implies that higher equity stock returns are associated with increased value relevance. These findings highlight the importance of market performance indicators, such as share price and returns, in determining the overall value relevance of firms.

On the other hand, the correlations between VR and both CPTE and PPTE are extremely weak, with values of 0.0011 and 0.0012 respectively. This indicates that there is virtually no linear relationship between value relevance and current or prior period tax expenses, suggesting that tax expenses have minimal direct impact on how value relevance is perceived in the market. Share Price (SP) similarly shows a very weak correlation with CPTE (0.0034) and PPTE (0.0034), implying that the share price is not significantly influenced by the firm’s tax expenses, whether current or from prior periods. Equity Stock Return (EST) has a very weak negative correlation with CPTE (-0.0028) and with PPTE (-0.0027), suggesting that variations in tax expenses have li-ttle to no meaningful impact on stock returns.

Current Period Tax Expenses (CPTE) and Prior Period Tax Expenses (PPTE) show an almost negligible negative correlation with each other (-0.0003), indicating no substantial linear relationship between these two tax expense metrics. This implies that past tax expenses have little predictive power for current tax expenses in this sample of firms. Overall, the pairwise correlations indicate mostly weak relationships between tax-related variables and firm value indicators such as VR, SP, and EST, with the exception of the strong positive correlations between VR and both SP and EST. This suggests that while market valuation and equity returns play a significant role in explaining value relevance, tax-related metrics do not exhibit a meaningful direct correlation with these indicators. The overall picture painted by these correlations is one of limited interaction between tax expenses and key firm value metrics, highlighting that other factors may be more critical in determining firm value.

The findings of this study provide significant insights into the effects of income taxes and on the value relevance of financial information for selected African listed firms. The analysis revealed that income tax expense has a statistically significant negative impact on the value of the firms, suggesting that investors may view higher tax expenses as detrimental to a firm's profitability and future earnings potential. This finding supports the rejection of the null hypothesis, indicating a significant relationship between income tax expenses and the value relevance of financial information.

Recommendations

Based on the findings from the analysis, recommendations can be made to improve the value relevance of financial information and enhance the understanding of income taxes accounting practices among African listed firms.

Limitations of the Study

There are many limitations encountered in this study that must be acknowledged to provide context to the findings and their applicability. This geographical limitation means that the findings may not be generalizable to firms outside the African continent or to unlisted firms within Africa. Also, the study period spans from 2013 to 2022, the timeframe may not be sufficient for robust analysis and may not capture longer-term trends or cyclical variations that could affect the value relevance of income taxes accounting practices.

Suggestions for Further Studies

Future research should consider incorporating a broader range of variables to improve the explanatory power of the models used in this study. While this research focused on income tax expenses, and other factors such as macroeconomic conditions, industry-specific dynamics, and firm-specific characteristics could provide a more comprehensive understanding of the determinants of firm value. Variables like inflation rates, exchange rates, market volatility, and operational efficiency metrics should be included in subsequent analyses to capture the multifaceted nature of firm valuation. The study should expand the geographical scope to include firms from other emerging markets or developed economies

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The authors declare no competing interests.

Income Tax Expense and Value Relevance of Selected African Listed Firms

Status:

Version 1

Abstract

Figures

1. INTRODUCTION

2. Literature Review and Hypothesis Development

3. Methodology

3.6 Model Specifications

4. DATA PRESENTATION AND ANALYSIS