Deferred taxes and cost of debt: evidence from Japan

Abstract

This paper investigates the information content of deferred taxes in the Japanese debt market by analyzing the relationship between deferred taxes and cost of debt. We find that while deferred tax liabilities are positively associated with cost of debt, deferred tax assets are not. This evidence may reflect the greater probability of tax obligations being realized compared to tax benefits. Further, we analyze the relationship between cost of debt and the various components of deferred taxes. We find that net deferred taxes caused by temporary differences are negatively related to cost of debt. On the other hand, net deferred taxes from net operating losses are positively related to cost of debt. Additionally, we find that valuation allowances are less positively related to cost of debt when firms are suspected of seeking to avoid losses or decreases in earnings. These results suggest that debt investors in the Japanese debt market evaluate the various components of deferred taxes differently.