[Current reporting rules require inter-period tax allocation whereby the income tax expense reported in the income statement is determined on the basis of pretax book (accounting) income, adjusted for permanent differences between the period's taxable income and book income. The temporary differences accumulate on the balance sheet as a deferred tax liability and are assumed to reverse in future years, gradually reducing the liability. Opponents of interperiod tax allocation argue that reversal of these temporary differences is unlikely or will occur only in the remote future. Thus, support has developed for either partial allocation (e.g., allocating only short-term temporary differences) or no deferral at all. Regardless of such concerns, in 1987 the Financial Accounting Standards Board (FASB) reaffirmed the use of comprehensive interperiod tax allocation. In this study, we perform cross-sectional analyses relating unexpected stock returns around news disclosures about the Tax Reform Act of 1986 to pertinent firm characteristics in an attempt to assess whether the deferred tax liability is viewed as a liability. The main findings of the study are consistent with the hypothesis that investors view the deferred tax liability as a real liability. They appear to discount it according to the timing and likelihood of the liability's settlement. The remainder of the article is organized as follows. Section I describes the previous research on the informativeness of tax deferrals, outlines the hypotheses of this study, and details the procedures used to test them. Section II presents and discusses the results, and the final section provides concluding remarks.]

Presents cross-sectional analyses relating unexpected stock returns around news disclosures about the Tax Reform Act of 1986 (TRA) in the United States in the valuation of deferred tax liability. Previous research on the informativeness of tax deferrals; Study hypotheses and testing procedures; Events leading to the enactment of the TRA; Descriptive statistics.

While the theoretical relation between taxes and capital structure has been extensively analyzed, the empirical evidence on this issue has thus far been inconclusive. One of the main difficulties confronting previous empirical studies of the cross-sectional relationship between taxes and leverage was the control of intervening variables. The Tax Reform Act of 1986 (TRA), which drastically changed the tax regime, provides a unique opportunity to assess the interaction between taxes and leverage decisions in a controlled environment. We test the relationship between leverage and certain tax-related variables for a large sample of companies in the years surrounding the enactment of the TRA. The results support the tax-based theories of capital structure. The findings indicate that there exists a substitution effect between debt and nondebt tax shields, and that both corporate and personal tax rates affect leverage decisions.

[While the theoretical relation between taxes and capital structure has been extensively analyzed, the empirical evidence on this issue has thus far been inconclusive. One of the main difficulties confronting previous empirical studies of the cross-sectional relationship between taxes and leverage was the control of intervening variables. The Tax Reform Act of 1986 (TRA), which drastically changed the tax regime, provides a unique opportunity to assess the interaction between taxes and leverage decisions in a controlled environment. We test the relationship between leverage and certain tax-related variables for a large sample of companies in the years surrounding the enactment of the TRA. The results support the tax-based theories of capital structure. The findings indicate that there exists a substitution effect between debt and nondebt tax shields, and that both corporate and personal tax rates affect leverage decisions.]