Tax capitalization, abnormal earnings persistence and equity valuation

Many studies show that market value is not a linear combination of earnings and book value. My study shows that abnormal earnings persistence is the reason for this non-linearity. When abnormal earnings are negative, their persistence is increasing with return on equity and decreasing with firm size and firm growth. When abnormal earnings are positive, their persistence is increasing with return on equity, firm size, and firm growth. I contribute to the literature by using the Ohlson model to explain and test the non-linearity of the valuation model.; Whether the dividend tax is capitalized in stock prices or not, and how is it capitalized, are unsolved questions. Researchers have provided evidence both for and against dividend tax capitalization. My study addresses the dividend tax capitalization problem by introducing abnormal earnings persistence, and using a strictly theory-based empirical model, to demonstrate that the dividend tax is capitalized in stock prices.; My study introduces stock repurchase as an alternative method to dividends for firms to distribute profits. Results indicate that the capital gain taxes triggered by repurchase are also capitalized in stock prices. I find that both taxes are capitalized at the same time. Dividend tax capitalization and capital gain tax capitalization triggered by repurchase are substitutes to each other. In contrast to other research, I find that a combination of the dividend tax and capital gain tax is capitalized. I also find the timing of dividends matters. My explanation is that the payout policy of the firm depends on where the firm is in its growth cycle. Tax capitalization explains firms' financing behavior and payout policy.