New Evidence on Investors’ Valuation of Deferred Tax Liabilities

Abstract

Although deferred tax liabilities (DTLs) represent a significant financial statement liability for most firms, research reaches conflicting conclusions regarding investors’ valuation of these items. Using an expanded dataset of hand-collected tax footnotes, I examine the nuanced association between depreciation-related DTLs and firm value, extracted from a period when these relations may have been more easily analyzed by investors. I show that investors price depreciation-related DTLs as economic burdens, on average. Despite arguments that growing DTL balances might signal lack of reversals (and a lower likelihood of being priced), I show that investors price growing depreciation-related DTL balances. Finally, I find evidence that DTL pricing is sensitive to expectations of firms’ future tax status and that investors value the tax deferral associated with DTLs. As depreciation-related DTLs are by far the largest DTL component, my study provides important insights into the valuation of deferred tax balances.

Keywords: deferred taxes, discounting, valuation, tax avoidance, depreciation