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An International Meeting of American Accounting
Association
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Creating a Bigger Bath Using the Deferred Tax Valuation Allowance |
Kurt J. Bennion
Cornell University
Theodore E. Christensen
Brigham Young University
Gyung H Paik
Brigham Young University
Earl K Stice
Brigham Young University
Abstract: The provisions of SFAS No. 109 allow a company to make an earnings big bath even bigger through the establishment of a deferred tax valuation allowance. We use a valuation allowance prediction model to identify those firms that are most likely to have recognized a valuation allowance as part of an earnings big bath. We find that firms that overstate their valuation allowance (bigger bath firms) are more likely than firms that understate their valuation allowance (smaller bath firms) to reverse their valuation allowance in the year following the non-cash charge, suggesting that some firms use the valuation allowance as a reserve to be used as part of an earnings management strategy. We also find that bigger bath firms have significantly higher stock returns than smaller bath firms in the two years following the special charge. Finally, we find that investors reward bigger bath firms that do not subsequently reverse their valuation allowance as part of an earnings management strategy.