The Valuation of Deferred Taxes*

Abstract

We provide evidence regarding the incremental value- relevance of deferred tax information provided under SFAS No. 109. We assess the likelihood of reversal for each component of the deferred tax disclosures required by SFAS No. 109, forming expectations about the direction and magnitude of these components' valuation. Based on these data, we measure the extent to which the valuation of deferred tax components depends on the probability of reversal. Our empirical work tests the hypothesis that deferred taxes that are more likely to reverse in the next period will contribute more to firm value (in absolute terms) than deferred tax components that are less likely to reverse soon. Our model values a firm's equity as a linear function of net operating assets, net financial assets, and current and lagged abnormal operating earnings. We introduce net deferred tax liabilities as a distinct category of (negative) assets in the valuation model and estimate the effect of each different asset class on the market value of the firm's equity. We find that, on average, one dollar of net operating assets is valued as a dollar; a dollar of net financial assets contributes less than one dollar to equity value; and a dollar of net deferred taxes is valued slightly more than a dollar. Separating a firm's deferred tax balance into its component parts provides further, more specific information relevant to firm value. We classify deferred tax components into seven categories, including depreciation and amortization; taxes and losses carried-forward; and restructuring charges. In particular, the valuation coefficient on deferred tax liabilities