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The information content of the deferred tax valuation allowance: Evidence from VC backed IPO firms.

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Title:The information content of the deferred tax valuation allowance: Evidence from VC backed IPO firms.
Authors:Allen, Eric
Keywords:Valuation Allowance
Initial Public Offering
Net Operating Loss
Deferred Tax Asset
Date Issued:31 Aug 2018
Abstract:I examine the accounting choices of startup firms in the period immediately prior to their initial public offering (IPO) regarding one specific account - the deferred tax valuation allowance. This is one of the largest accruals for these firms, on average 73% of assets, and given its forward looking nature, should contain significant information for firm investors at the time of the Initial Public Offering (IPO). I first find that the distribution of the allowance is essentially binary, with 14% of the firms recording no allowance, and 76% of the firms recording a ‘full’ allowance completely offsetting any deferred tax assets. I further find that this choice is almost entirely predicted by whether the firm reports a history of losses in the pre-IPO period. For firms with a net operating loss carryforward (NOL) and pre-tax loss in the period immediately prior to IPO the likelihood of recording a full allowance is approximately 90%. For profitable firms without an NOL, it is less than 1%. This reliance on historical performance is consistent with auditors ignoring manager expectations of future profitability when making the decision to record the allowance, and increased SEC monitoring around the IPO reducing the ability of firms to manage earnings. Finally, I find that the valuation allowance sends a strong negative signal for future operating performance and firm survival, consistent with the choice to record a full allowance reflecting firm fundamentals. The results stand in contrast to literature which argues IPO firm financial disclosures lack sufficient relevance and reliability to provide useful information to investors.
Appears in Collections: 08 Taxation

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