Book–tax differences and earnings persistence: The moderating role of sales decline

Abstract

This is an open access article under the CC BY license.This study investigates why firms with large book–tax differences (BTDs) exhibit lower earnings persistence, particularly during periods of revenue declines. While prior literature has linked BTDs, especially large positive BTDs (LPBTDs), to earnings management, we propose an alternative explanation rooted in operational disruptions. Using a large panel of U.S. firms from 1995 to 2016, we examine whether short-term earnings persistence is affected by sales trends and the direction of BTDs. Our findings reveal that both large positive and large negative BTDs are significantly associated with reduced earnings persistence when sales decline. The effect is pronounced in both accrual and cash flow components of earnings. We develop and test a framework based on “operations theory,” which attributes this reduction to real business shocks, such as asset write-downs, facility closures, and reserve adjustments, that arise during sales decline periods. These results highlight the importance of distinguishing operationally driven BTDs from those arising through discretionary accruals. Our findings have implications for investors, regulators, and researchers seeking to interpret BTDs more accurately in volatile economic environments. © 2025 by the authors