The Information Content of Tax Expense for Firms Reporting Losses
42 Pages Posted: 28 Jun 2010 Last revised: 19 Apr 2012
Date Written: April 17, 2012
We investigate whether management’s decision regarding the recognition of the valuation allowance for deferred tax assets (VA) under ASC 740 provides incremental information about the persistence of accounting losses. We introduce a classification scheme that assigns loss firm-years into three categories based on whether management appears to have recognized a material change in the VA and whether the firm has positive taxable income or not (e.g., a net operating loss). The results of our study show that our tax categories contain information about the persistence of accounting losses over the following three years beyond variables previously identified to predict loss persistence. This incremental information is consistent with management using private information about the firm’s future prospects in setting the VA. Finally, we find that investors’ pricing of the VA varies with the saliency of the tax signal and the information environment of the firm.
Keywords: Tax Expense, Deferred Taxes, Valuation Allowance, Loss Firms, Accounting Losses
JEL Classification: G12, G14, H25, M41
Suggested Citation: Suggested Citation