The Information Content from Releases of the Deferred Tax Valuation Allowance

Abstract

We examine the extent to which deferred tax valuation allowance (VA) releases - a discretionary accounting judgment that increases net income based on estimated future tax benefit realizations- are predictive of future earnings. We first find that profitable firms releasing at least a portion of a full VA have higher subsequent earnings relative to a control group that maintains a full VA. These results vary depending on firms’ cumulative profitability in recent years and suggest some firms appear to rely on historical fact patterns rather than estimations of future profitability to justify the VA release. In additional analysis, we observe that among firms lacking cumulative profits in recent years, VA releasers generate higher subsequent abnormal returns than VA maintainers, suggesting investors are not timely responding to the information content from the VA release decision.

Keywords: valuation allowance, future earnings, buy-hold abnormal returns

JEL Classification: M41