American Taxation Association
JATA - 2001 Supplement
Volume 23 supplement
Do Firms Use the Deferred Tax Asset Valuation Allowance to Manage Earnings?
The Impact of Deductibility Limits on Compensation Contracts: A Theoretical Examination
The Influence of Firm Maturation on Firms' Rate of Adjustment to Their Optimal Capital Structures
Jim A. Seida
The tax-clientele theory suggests that higher (lower) tax-rate investors should, ceteris paribus, concentrate their portfolios in tax-favored (explicitly taxed) assets. While evidence supporting the tax-clientele theory exists, research on tax-induced dividend clienteles for common stocks is mixed. This study examines trading activity, measured using daily transaction data, following dividend increases for evidence of shareholder clientele changes. Consistent with implications of the tax-induced dividend clientele theory, I document a strong positive association between dividend increase magnitude and post-dividend-increase trading activity. This result provides evidence that tax clienteles for dividend policies exists and that their effect is strong enough to influence investors' decisions. Further, consistent with dividend clienteles existing, I find that the relation between dividend-increase magnitude and postdividend- increase trading activity decreases with higher pre-dividend-increase dividend levels. Top
Christine C. Bauman, Mark P. Bauman and Robert F. Halsey
This study utilizes a sample comprised of Fortune 500 firms to examine earnings management via changes in the deferred tax asset valuation allowance. The study extends existing research in three ways. First, we document that the earnings effect of a valuation allowance change often cannot be determined from financial statement disclosures. Based on an analysis of sample firms' income tax footnotes, we offer suggestions to improve disclosure policy.
Second, prior research uses the net change in the valuation allowance account as a proxy for the earnings effect of valuation allowance changes. We argue that the amount reported in the effective tax rate reconciliation is a better measure of the income statement effect and document certain significant differences between the measures.
Third, prior research employs cross-sectional regression models in an effort to make generalizations about earnings management behavior. In contrast, we use a contextual approach to assess whether observed valuation allowance changes are consistent with different motivations for earnings manipulation. The contextual analyses are based on identifying firms in the position to engage in various forms of earnings management and examining the earnings effect of valuation allowance changes made by firm managers. Cross-sectional tests find virtually no evidence in support of earnings management. Of particular note, we find that the incidence of "big bath" behavior may be exaggerated. In contrast, a contextual approach identifies specific instances in which earnings management may exist. Thus, the analysis of valuation allowance changes is contextual and requires careful consideration of activity in the allowance account. This point underscores the deficiency in income tax reporting and the need for increased disclosure in this area. Top
Robert M. Halperin, Young K. Kwon and Shelley C. Rhoades-Catanach
In 1993, Congress passed § 162(m) of the Internal Revenue Code. Section 162(m) disallows a deduction for compensation in excess of $1,000,000 paid to the chief executive officer (CEO) and the four highest compensated officers other than the CEO of a publicly traded corporation unless the excess is "performance-based." Several articles in the popular and professional press (The New York Times 1993; The Journal of Taxation 1994) predicted that executives whose nonperformance-based compensation exceeded $1,000,000 before the passage of the legislation would find their salaries reduced and their performance-based compensation increased as a result of the legislation. Other predictions regarding the impact of § 162(m) have been mixed, with some commentators predicting no real effect (Burzawa 1993).
While several empirical studies have examined firm reactions to § 162(m) in terms of compensation packaging, no prior research has considered the impact of this legislation on executive performance. This paper provides a theoretical examination of both firm and executive responses to the deductibility limit imposed by § 162(m). The results of this study may be useful to tax policymakers considering the effectiveness of § 162(m) in meeting Congressional objectives, and to empirical researchers examining the impact of this legislation on firm and executive performance. Top
Jeffrey A. Pittman and Kenneth J. Klassen
Extant empirical research on firms' adjustment to their optimal capital structures is cross-sectional. However, Scholes and Wolfson (1989) argue that refinancing costs that accumulate with age increasingly impede firms from restoring their optimal capital structures. This study provides evidence on the time-series variation in the rate at which firms move toward their leverage targets that is consistent with this prediction. In separate tests, age is measured from two dates—from firms' initial public offerings and from their incorporation—to examine whether the duration of their public and private experience, respectively, affect the evolution in financial policies. This paper contributes to the literature by developing a research design that isolates the influence of dynamic refinancing costs on the leverage adjustment problem. The evidence also justifies future research on Scholes and Wolfson's (1989) predictions about the time-series pattern in firms' tax shields by empirically validating that refinancing costs increasingly constrain their capital structures. Top