The valuation of deferred taxes

Abstract

We examine the value relevance of deferred tax components disclosed under SFAS No. 109. We classify deferred tax components into seven categories: depreciation and amortization; losses and credits carried forward; restructuring charges; environmental charges; employee benefits; valuation allowance required by SFAS No. 109; and all other components. We find that separating deferred taxes into components provides value relevant information. In particular, the valuation coefficient on deferred tax liabilities from depreciation and amortization is close to zero, reflecting investors' expectations that firms will continue to invest in depreciable assets reducing the probability of future reversal. Also, deferred taxes from restructuring charges have valuation coefficients larger than other deferred tax components, reflecting the higher likelihood of reversal in the short run. Finally, we find that the net realizable value of deferred taxes from losses and credits carried forward is negatively associated with stock prices. This result suggests that investors do not expect part of these carryforwards to be utilized, although we cannot rule out the possibility that model misspecification is driving this result.