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The Information Content of Tax Expense for Firms Reporting Losses

Authors


  • Accepted by Merle Erickson. We appreciate helpful suggestions from Orrie Barron, Jim Boatsman, Jenny Brown, Jeffrey Burks, Katharine Drake, David Farber, Paul Fischer, Jere Francis, Dan Givoly, Steve Huddart, Yuchang Hwang, Bin Ke, Inder Khurana, Petro Lisowsky, Michaele Morrow, Mark Peecher, Raynolde Pereira, Thomas Schaefer, Jim Seida, Theodore Sougiannis, an anonymous reviewer, and participants in the Spring 2009 University of Arizona Doctoral Tax Seminar. The paper has also benefited from the comments of workshop participants at the 2010 AAA Annual Meeting, Arizona State University, Penn State University, University of Kansas, University of Illinois at Urbana–Champaign, University of Missouri, and University of Notre Dame.

ABSTRACT

We investigate whether management's decision regarding the recognition of the valuation allowance (VA) for deferred tax assets 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 or not the firm has positive taxable income (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.

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