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Open Access Publications from the University of California

The information content of the deferred tax valuation allowance for venture capital backed IPO firms.

  • Author(s): Allen, Eric James
  • Advisor(s): Dechow, Patricia
  • Sloan, RIchard G.
  • et al.

In this dissertation I examine the deferred tax disclosures of a unique sample of venture capital backed firms that conducted their initial public offering (IPO) between 1996 and 2008, and generated a net operating loss (NOL) carry-forward. I find that 83% of the sample firms record an allowance fully valuing-out the carry-forward's associated deferred tax asset. This full allowance is, on average, 72% of total assets - a fact which provides strong evidence (at least in terms of this accrual) that these firms are not upwardly managing their earnings prior to IPO. I show that the size of a firm's NOL, and proxies for its expectation of future taxable income have significant predictive power for the magnitude of the valuation allowance. I also show that the allowance sends a strong negative signal about a firm's future book income. Both of these results support the contention that, though conservative, the valuation allowance does provide information about an IPO firm's economic fundamentals. Finally, I introduce a new explanation for the presence of the allowance: the ownership change limitation. This limitation can cause a firm to record an allowance independent of its expectations about future earnings. I provide evidence that firms take this limitation into account when recording the valuation allowance, and that controlling for it can enhance the allowance's signal regarding future income.

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