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Empirical implications of incorrect special item tax rate assumptions

Abstract

The use of assumed tax rates to adjust special items (e.g., restructuring charges, asset writedowns, etc.) is common in empirical accounting research as these items are reported pre-tax and are often used in research designs that include after-tax earnings. This study explores the potential empirical consequences of assuming an incorrect tax rate in adjusting special items. We focus on special items given their prevelance in the literature as well as the wide variation in tax rate assumptions from these studies. Our investigation shows that the tax rate assumed can be critical to the interpretation of results. Importantly, our evidence suggests extreme tax rate assumptions, in particular the highest statutory rate, are especially problematic and yield dramatically biased estimates. Our review of the tax consequences of special items suggests that, in almost all circumstances, the marginal tax rate is the theoretically correct rate to apply to these items when adjusting for tax. Consistent with this view, our empirical evidence, with a limited exception, suggests that marginal tax rates represent the best estimate of the true tax rate. By providing empirical evidence on the potential empirical consequences of these varied tax rate assumptions, we offer a guide for future researchers on the importance of this critical design choice.

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Notes

  1. Compustat classifies material nonrecurring items that are reported above the line as ‘‘special items” and reports aggregate special items on a pre-tax basis. Special items include such items as restructuring charges, asset impairments, plant closing costs, and termination benefits. We discuss special items in greater detail in the next section.

  2. The tax rate adjustment is to multiply the reported special item by (1-t) where t is the assumed tax rate. Assumed tax rates include zero (no adjustment), the top statutory rate, an estimated marginal rate, a calculated effective tax rate, or using after-tax special item components in Compustat (added in 2001 and discussed further below).

  3. We discuss our method for identifying these studies in greater detail in the literature review section.

  4. Our own analysis finds that the annual reporting of special items almost doubled between 2000 and 2017.

  5. Commonly known as “persistence” of earnings, though persistence becomes confusing when dealing with negative special items. Burgstahler et al. (2002) use the term “inter-period” transfer, and Cready et al. (2012) use the term “expense” transfer as the latter study focuses solely on negative special items. We use the term “income” transfer throughout as encompassing the fact that special items may include gains, losses, revenues, and expenses.

  6. “Income-transfer” refers to firms transferring current or future normal operating expenses (revenue) into special items, thereby increasing (decreasing) current or future earnings before special items (Burgstahler et al. 2002, pp. 590–591).

  7. We examined the tax footnote of 25 randomly selected large pure restructuring charge observations (where the charge was the only special item reported and at least 1 percent of assets). As reported in Appendix 2, Panel C, of these 25 observations, 22 report negative pre-tax income, and the mean (median) deferred tax valuation allowance for these observations is 65 (88) percent of the deferred tax asset.

  8. If the deferred tax valuation allowance equals 100 percent of the deferred tax asset, management’s expectation of future income is insufficient to realize the deferred tax asset, assuming that management’s estimate of future taxable income is unbiased. However, research shows this allowance may be managed (e.g., Frank and Rego 2006).

  9. However, this situation is complicated by different deductibility rules depending on how the goodwill is acquired. Although most goodwill is nondeductible (i.e., goodwill recognized through stock acquisitions), a nontrivial amount of goodwill is amortized for tax purposes (i.e., goodwill obtained in cash acquisitions).

  10. Quarterly changes in earnings have the largest effect on future earnings in the fourth subsequent quarter, reflecting the seasonality of quarterly earnings. Thus, in the income-transfer model, the largest influence of a special item on future earnings will be reflected in the fourth subsequent quarter. See page 599 Burgstahler et al. (2002) for a thorough discussion.

  11. We discuss the effect of valuation allowances in Section III and potential explanations for the restructuring sample differences along with the results of the restructuring subsample tests in Section V.

  12. Shielding is the degree to which compensation committees add a negative special item back to income before setting earnings-based bonuses. Full shielding implies that 100 percent of the charge is added back, no shielding implies that none of the charge is added back, and partial shielding implies that part of the charge is added back. See Dechow et al. (1994, p. 142) for a full discussion of how empirical results are interpreted as no, partial, or full shielding.

  13. To avoid citation inflation, all 71 papers are not included in the reference section but are available from the authors upon request. We only include references for papers directly cited in the manuscript.

  14. A recent study by Cain et al. (2020) in Management Science also provided a relatively comprehensive list of special items research. This process may have resulted in omissions, but the studies identified are used for descriptive purposes and context on the relevance of special items and tax adjustments in published research. Furthermore, this list does not include studies similar to the work of Doyle et al. (2003), who define special items other than the Compustat provided variables, or studies that use incidence of special items solely as a partition or indicator.

  15. To clarify, PTB matches both pre-tax earnings to the reported special item (measured pre-tax). The ZERO assumption matches after-tax earnings with pre-tax special items, seemingly mismatching special items and earnings. While some studies explicitly assume a zero tax rate (e.g., Dechow and Ge 2006), others are silent but the inclusion of special items as reported with after-tax earnings implicitly assumes a zero tax rate. That said, this may be the appropriate assumption in certain circumstances, as we discuss and investigate below.

  16. Since many studies include more than one analysis/dependent variable, the total adds up to 108 dependent variables in the 71 identified studies.

  17. The income-transfer model in its simplest form is based on the work of Bernard and Thomas (1990), who demonstrate that the predictable relation between current and future quarterly earnings is not fully impounded in prices.

  18. These inferences are of course reversed when the actual tax rate exceeds the true tax rate. This is unlikely when the top statutory rate is used but possible when a zero rate is assumed.

  19. Our observations suggest Compustat generally assumes the highest statutory rate (TOP) with exactly 35% assumed for over 70 percent of our sample of special item observations. The zero tax rate (ZERO) is assumed for approximately 10 percent of our sample of special items. For those in between, there is no clear calculation (e.g., ETR) for the rate as far as we can tell. We cannot ascertain how this choice is made and the Compustat manuals provide no clarification.

  20. We assume a statutory tax rate of 35 percent in this example because our sample period predates the establishment of a 21 percent flat corporate tax rate under the Tax Cuts and Jobs Act. However, substituting a 21 percent tax rate in our example leads to the same conclusion that the ETR is a flawed estimate of the true tax rate. Tax expense at 21 percent would equal 30 * TOP = $6.30, resulting in after-tax earnings before NSIs of 40 − $6.30 = $33.70.

  21. Goodwill deductibility is a complex situation depending on the structure of the acquisition. Generally, stock-for-stock (cash for asset) acquisitions result in nondeductible (deductible and amortized over 15 years) goodwill, though there are exceptions and also mixed consideration transactions (e.g., Henning and Shaw 2000; Ayers et al. 2000; 2004; Martin 1996; Erickson 1998; Oler 2008). Khalil et al. (2021, Appendix B) explain the timing issues for taxable acquisitions, and their study examines a strategy for deducting impairments of goodwill.

  22. We perform the same analyses for a smaller sample of 25 positive special items observations (reported in Appendix 2, Panel B) and find that the mean (median) valuation allowance is 42.8 (18.0) percent of the deferred tax asset. We also find that 28 percent have a valuation allowance greater than 95 percent and 8 percent have no allowance. Of these firms, 23 of 25 report positive pre-tax income.

  23. Our review of the Compustat manuals as well as company disclosures suggests that, with the exception of nondeductible goodwill impairments, every component of special items is currently taxable or a temporary timing difference. That said, there may be limited circumstances where a portion of an item gives rise to a permanent book-tax difference. We note the following examples: 1) debt repurchases that are governed by restrictions under IRC §249, 2) gains from debt forgiveness where the firm is allowed to exclude the cancellation of debt income due to bankruptcy or insolvency, 3) fines and penalties on settlements, 4) interest or fines on tax settlements, 5) nontaxable insurance settlements. We believe instances of these items occurring in the data are limited.

  24. The marginal tax rates provided by Professor Graham account for many important features of the tax code, including uncertainty about taxable income, deferred taxes, the progressivity of the statutory tax schedule, net operating loss carryforwards and carrybacks, certain tax credits, and the alternative minimum tax. The data are available at his website: http://faculty.fuqua.duke.edu/~jgraham/taxform.html. We thank him for making this data available.

  25. We do so to calculate the implied Compustat tax rate on total special items. Compustat provides after-tax values for the individual special item components (e.g., restructuring charges) but not for total special items.

  26. Compustat reports each of the components of special items (e.g., restructuring charges, goodwill impairments, etc.) on both a pre- and after-tax basis, but total special items (SPIQ) are only reported on a pre-tax basis. Thus this method is effectively the weighted-average tax rate assumed by Compustat on total special items.

  27. Cready et al. (2012, Table 3, p. 1179) report income transfer for the pre-tax model of 7.8 percent.

  28. Evaluating positive special items is particularly difficult because, as Appendix 1 makes clear, many PSIs are merely the reversal of a prior NSI that must have been overestimated when originally reported.

  29. This assumes an examination of aggregate goodwill impairments (i.e., both deductible and nondeductible) as in the current study.

  30. We do not replicate all 71 studies but include examples of the main genres of research to note the possible empirical implications of assumed tax rates in various contexts. Sample selection and descriptive statistics for the following tests are not tabulated but were compared with the studies in each area to confirm proper replication was achieved. Sample selection and descriptive results are available from the authors upon request.

  31. NSIs are entered as positive values in the model.

  32. Elliott and Hanna (1996) implicitly assume a zero tax rate on special items. Cready et al. (2010), in their analyses, adjust special items at the firm’s quarterly effective tax rate.

  33. Interestingly, in untabulated sensitivity analyses, these findings are unrelated to pre-tax income versus losses as the results hold nearly identically in subsamples split on this dimension. We thank an anonymous reviewer for suggesting this sensitivity test.

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Acknowledgements

We greatly appreciate the many helpful comments we have received through multiple versions of this manuscript. In particular, we thank Brooke Beyer, Robert Gary, Molly Mathis, Jared Moore, and Steve Rock. We also thank workshop participants at the 2017 Colorado Accounting Research Symposium, the 2019 Oklahoma State University School of Accounting Ph.D. Alumni Research Conference, and the 2019 American Accounting Association Annual Meeting, especially discussant Anup Srivastava. We are especially appreciative of Editor Jennifer Blouin and an anonymous referee for valuable feedback in helping to shape the final product. Finally, we would like to express special thanks to John Graham for providing us access to his MTR data.

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Appendices

Appendix 1. Compustat Special Items

The Compustat User’s Guide states that “special items” represent “unusual or nonrecurring items presented above taxes by the company.” Special items (when reported above taxes) includes:

  1. 1.

    Adjustments applicable to prior years (except recurring prior year income tax adjustments)

  2. 2.

    After-tax adjustments to net income for the purchase portion of net income of partly pooled companies when the adjustment is carried over to retained earnings

  3. 3.

    Any significant nonrecurring items

  4. 4.

    The current year’s results of discontinued operations and operations to be discontinued

  5. 5.

    Flood, fire, and other natural disaster losses

  6. 6.

    Impairment of goodwill/unamortized intangibles

  7. 7.

    Interest on tax settlements (when reported separately from other interest expense)

  8. 8.

    Inventory write-downs when reported separately or called “nonrecurring”

  9. 9.

    Nonrecurring profit or loss on the sale of assets, investments, securities, among others

  10. 10.

    Profit or loss on the repurchase of debentures

  11. 11.

    Purchased research and development

  12. 12.

    Relocation and moving expense

  13. 13.

    Reserve for litigation

  14. 14.

    Restructuring charges (includes closing and exit costs)

  15. 15.

    Severance pay when reported separately on the income statement

  16. 16.

    Special allowances for facilities under construction

  17. 17.

    Transfers from reserves provided for in prior years

  18. 18.

    Write-down of assets

  19. 19.

    Write-downs or write-offs of receivables, intangibles, among others

  20. 20.

    Write-offs of capitalized computer software costs

  21. 21.

    Year 2000 expenses

The Compustat Data Guide notes the following items are specifically excluded from special items:

  1. 1.

    Any special item listed above as “include” that appears every year for the last three years, unless it has specifically been called restructuring, special, or nonrecurring. (Additionally, this does not apply to Year 2000 expenses, impairment of goodwill, extinguishment of debt, settlements, in-process R&D, or purchased R&D.)

  2. 2.

    Foreign exchange (currency) adjustments (included in Nonoperating Income [Expense])

  3. 3.

    Gain/loss on sale of marketable securities for companies that have adopted SFAS #115

  4. 4.

    Idle plant expense (included in Nonoperating Income [Expense])

  5. 5.

    Interest on tax settlements, when included by the company with other interest expense (included in interest expense)

  6. 6.

    Milestone payments or one-time contract reimbursements for R&D companies

  7. 7.

    Nonrecurring items that are included in equity in earnings

  8. 8.

    Profit or loss on sale of properties (except for securities, etc.) for the companies in the oil, coal, transportation, and other industries where these transactions are considered a normal part of doing business (included in Nonoperating Income [Expense])

  9. 9.

    Shipping firms’ operating differential subsidies and estimated profit adjustments for preceding years. Prior years’ operating differential subsidies are included in Nonoperating Income (Expense). Current year operating differential subsidy is included in sales. Adjustments by shipping companies to estimated profits reported by this method are ignored.

Beginning in 2001, the following special items breakout categories are provided by Compustat, with options for: pretax, after-tax, basic EPS, and diluted EPS effect (though data may be missing for many of these items).

Data Field Included Items per Compustat Interpretation of Negative Special Items Interpretation of Positive Special Items
Acquisitions & mergers (AQ) Costs of failed acquisitions Deductible in year deemed paid Indicates reversal of a prior-period GAAP adjustment
Extinguishment of debt (DTE) Gain on repurchase or retirement of debt N/A Cancellation of debt income is generally taxable, but exceptions are made for bankrupt or insolvent companies
Loss from prepayment of debt Deductible in year deemed paid N/A
Adjustments related to SFAS 145 GAAP adjustment GAAP adjustment
Impairment of goodwill (GDWLI) Write-off of goodwill, impairment of unamortized intangibles GAAP impairment charge is a permanent difference, but Sec. 197 intangibles (e.g., Goodwill) amortized over 15 years for tax purposes; unrecovered basis recognized as loss for tax purposes upon abandonment or disposal Indicates reversal of a prior-period GAAP adjustment
Gain/loss (GL) Gain/loss items, including amounts from restructuring, not related to impairments or dilution Loss recognized for tax purposes upon disposal Gain recognized for tax purposes upon disposal
Restructuring costs (RC) Severance, closing costs, exit costs, reductions in workforce, rationalizations, realignment, relocation charges, repositioning, early retirement, Chapter 11 reorganization costs, Chapter 11 expenses Generally deductible, either as incurred or subject to capitalization and amortization Indicates reversal of a prior-period GAAP adjustment
In-process research & development (RDIP) Portion of R&D considered to be “purchased” and written off immediately upon acquisition if the R&D items are deemed not to have an alternative use Generally deductible when the project is finally abandoned and deemed worthless Indicates reversal of a prior-period GAAP adjustment
Litigation & insurance settlements (SET) Provisions to adjust reserves for litigation and settlements, Insurance recovery proceeds Deductible in year deemed paid Indicates reversal of a previous GAAP adjustment or receipt of insurance proceeds (generally tax-exempt) offsetting prior-period loss
Write-downs (WD) Impairment or write-down of assets other than goodwill and unamortized intangibles GAAP impairment charge is a permanent difference, but Sec. 167 intangibles (e.g., noncompete agreements) amortized over useful life; unrecovered basis recognized as loss for tax purposes upon abandonment or disposal Indicates reversal of a prior-period GAAP adjustment
Other special items (SPIO) Gain/loss attributable to pension, post retirement curtailment, settlement, termination Deductible in year deemed paid Gain recognized for tax purposes upon disposal, GAAP adjustment not taxable
Dilution gains/losses GAAP adjustment GAAP adjustment

Appendix 2

Panel A : Detailed examination of random sample of 100 firms where |NSI|÷ Assets > 1.0%

# Company Name FYear Qtr NSI Assets NSI% PTI DTA VA %VA ETR MTR
1 Restoration Hardware Holdings, Inc 2016 4  − 23.773 2,192.520  − 1.08% 15.156 28.466 0.76 2.67% 37.7% 4.3%
2 Krispy Kreme Doughnuts, Inc 2007 2  − 10.600 255.936  − 4.14%  − 26.831 176.964 176.964 100.00% 0.0% 1.3%
3 Silgan Holdings, Inc 2003 4  − 19.513 1,621.084  − 1.20%  − 4.029 142.342 18.713 13.15% 39.6% 7.6%
4 Juniper Networks, Inc 2009 4  − 184.543 7,590.263  − 2.43% 3.948 531.2 112.8 21.23% 0.0% 2.2%
5 Sourcecorp, Inc 2004 3  − 10.165 457.902  − 2.22%  − 2.198 11.589 0 0.00% 81.7% 4.2%
6 Weyerhaeuser Company 2017 3  − 209.000 18,402.000  − 1.14% 103.000 620 63 10.16% 0.0% 2.6%
7 NewMarket Corporation 2006 4  − 7.477 744.793  − 1.00% 3.711 59.189 0 0.00% 9.9% 30.5%
8 Zale Corporation 2003 2  − 136.300 1,449.503  − 9.40% 6.683 44.627 0 0.00% 100.0% 4.4%
9 Zimmer Biomet Holdings, Inc 2015 3  − 316.600 26,689.100  − 1.19% 31.800 895.6 72.7 8.12% 30.2% 35.0%
10 MTS Systems Corporation 2010 3  − 6.148 359.188  − 1.71%  − 1.563 21.167 0.986 4.66% 100.0% 3.0%
11 Tuesday Morning Corporation 2003 4  − 3.854 253.394  − 1.52% 56.667 7040 0 0.00% 38.4% 35.0%
12 InterMune, Inc 2006 2  − 30.000 224.967  − 13.34%  − 44.018 252 252 100.00% 0.0% 0.7%
13 Abercrombie & Fitch Co 2013 3  − 46.298 2,852.396  − 1.62%  − 37.025 176.076 0.202 0.11% 57.7% 35.4%
14 Electronic Arts, Inc 2007 4  − 156.000 6,059.000  − 2.57%  − 136.000 424 22 5.19% 31.6% 4.6%
15 Model N, Inc 2017 2  − 3.563 175.622  − 2.03%  − 16.600 92.493 78.003 84.33% 24.8% 1.7%
16 J. C. Penney Company, Inc 2011 3  − 265.000 12,751.000  − 2.08%  − 226.000 708 0 0.00% 36.7% 32.6%
17 The Scotts Miracle-Gro Company 2011 4  − 31.200 2,052.200  − 1.52%  − 110.200 208.2 44.3 21.28% 34.9% 1.0%
18 LCA-Vision, Inc 2012 4  − 1.700 48.968  − 3.47%  − 5.832 26,377 26,377 100.00% 3.6% 1.6%
19 Ablest, Inc 2005 3  − 0.290 26.532  − 1.09% 0.590 2110 0 0.00% 37.8% 0.3%
20 DGSE Companies, Inc 2012 3  − 1.407 24.489  − 5.75%  − 0.403 8.73 8.73 100.00% 0.0% 2.9%
21 TTM Technologies, Inc 2016 4  − 48.908 2,500.076  − 1.96% 15.606 298.849 221.951 74.27% 100.0% 4.1%
22 Omnicare, Inc 2013 3  − 209.900 6,915.526  − 3.04%  − 95.701 288.611 24.159 8.37% 27.5% 2.6%
23 PLX Technology, Inc 2013 2  − 0.903 73.422  − 1.23% 1.734 67.173 67.173 100.00% 3.5% 3.2%
24 LSI Industries, Inc 2009 2  − 13.450 157.626  − 8.53%  − 14.006 10.222 1.94 18.98% 4.5% 2.8%
25 Fossil Group, Inc 2017 1  − 26.284 2,101.718  − 1.25%  − 48.009 127.25 78.314 61.54% 0.0% 4.4%
26 Castlight Health, Inc 2017 1  − 3.409 147.401  − 2.31%  − 14.374 112.968 112.968 100.00% 0.0% 2.5%
27 Regis Corporation 2005 3  − 38.319 1,701.128  − 2.25%  − 5.214 17.229 0 0.00% 0.0% 35.0%
28 Dycom Industries, Inc 2008 4  − 9.295 789.036  − 1.18% 6.253 37.395 0.33 0.88% 26.6% 4.8%
29 Intelligent Systems Corporation 2008 4  − 0.369 8.706  − 4.24% 0.179 11.606 11.606 100.00% 0.0% 1.2%
30 PolyOne Corporation 2014 2  − 39.300 2,846.700  − 1.38% 33.300 205.4 23.6 11.49% 7.8% 4.0%
31 LifeVantage Corporation 2017 1  − 1.011 49.796  − 2.03% 1.678 5.24 0.312 5.95% 29.7% 2.8%
32 O’Charley’s Inc 2008 3  − 47.987 588.494  − 8.15%  − 53.008 67.806 65.791 97.03% 0.0% 0.6%
33 Kirkland’s, Inc 2003 4  − 1.053 103.129  − 1.02% 23.587 3.326 0 0.00% 39.1% 35.0%
34 Mines Management, Inc 2007 4  − 1.000 42.157  − 2.37%  − 3.184 3.77 3.77 100.00% 0.0% 0.1%
35 Pinnacle Data Systems, Inc 2006 2  − 0.633 26.241  − 2.41% 0.086 1.507 0 0.00% 39.5% 34.0%
36 International Flavors & Fragrances Inc 2011 4  − 43.299 2,965.581  − 1.46% 40.530 478.322 290.879 60.81% 39.8% 1.0%
37 EnPro Industries, Inc 2009 2  − 113.900 1,169.200  − 9.74%  − 102.400 286.4 0 0.00% 0.0% 35.1%
38 Antares Pharma, Inc 2006 4  − 0.139 11.534  − 1.21%  − 1.414 22.588 22.588 100.00% 0.0% 0.1%
39 Revlon, Inc 2012 3  − 26.300 1,183.600  − 2.22%  − 3.500 373.2 70.6 18.92% 0.0% 2.1%
40 Lowe’s Companies, Inc 2016 3  − 432.000 35,370.000  − 1.22% 776.000 1229 578 47.03% 51.2% 1.0%
41 Elizabeth Arden, Inc 2008 4  − 27.926 970.734  − 2.88%  − 19.440 42.02 0.823 1.96% 46.3% 1.6%
42 OSI Pharmaceuticals, Inc 2004 4  − 64.799 388.029  − 16.70%  − 123.189 415.355 415.355 100.00% 0.0% 0.0%
43 inTEST Corporation 2017 4  − 7.580 62.493  − 12.13%  − 4.511 1.185 0.37 31.22% 0.0% 37.7%
44 Belden, Inc 2012 3  − 77.318 2,175.599  − 3.55%  − 77.573 151.572 7.498 4.95% 28.2% 2.4%
45 Maytag Corporation 2003 4  − 31.273 3,024.140  − 1.03% 30.320 421.774 38.171 9.05% 37.5% 30.3%
46 Align Technology, Inc 2009 3  − 71.579 330.784  − 21.64%  − 60.465 76.724 6.182 8.06% 17.4% 1.8%
47 Gibraltar Industries, Inc 2014 4  − 108.302 814.160  − 13.30%  − 107.332 28.814 0.4 1.39% 10.8% 33.3%
48 Myrexis, Inc 2012 4  − 1.834 91.651  − 2.00%  − 4.420 47.917 47.917 100.00% 0.0% 1.6%
49 Callaway Golf Company 2011 3  − 12.624 765.750  − 1.65%  − 47.733 119.197 110.844 92.99% 0.0% 1.0%
50 Meritor, Inc 2012 4  − 27.000 2,501.000  − 1.08% 12.000 1324 1204 90.94% 58.3% 24.6%
51 Herman Miller, Inc 2009 4  − 9.600 770.600  − 1.25%  − 0.200 94.9 11 11.59% 100.0% 26.0%
52 lululemon athletica, inc 2017 3  − 22.185 1,720.449  − 1.29% 86.640 64.395 1.843 2.86% 32.0% 1.0%
53 USG Corporation 2014 3  − 78.000 4,064.000  − 1.92%  − 9.000 1023 1023 100.00% 0.0% 1.6%
54 Cascade Corporation 2009 4  − 13.376 341.931  − 3.91%  − 13.454 51.186 22.011 43.00% 0.0% 1.4%
55 Volcano Corporation 2008 2  − 12.232 254.340  − 4.81%  − 13.230 37.27 37.27 100.00% 0.0% 1.3%
56 Valmont Industries, Inc 2014 3  − 31.905 2,862.721  − 1.11% 39.511 248.909 104.487 41.98% 36.0% 35.2%
57 Wolverine World Wide, Inc 2016 4  − 50.300 2,431.700  − 2.07%  − 7.900 128.5 11.5 8.95% 75.9% 1.0%
58 Carrizo Oil & Gas, Inc 2005 3  − 3.721 365.700  − 1.02%  − 11.052 2.793 0.274 9.81% 28.4% 5.1%
59 NutriSystem, Inc 2008 4  − 6.483 159.471  − 4.07% 0.981 9.689 3.749 38.69% 100.0% 35.1%
60 Adept Technology, Inc 2009 3  − 0.392 30.965  − 1.27%  − 3.555 39.721 39.721 100.00% 1.4% 0.7%
61 Advanced Micro Devices, Inc 2014 4  − 301.000 3,767.000  − 7.99%  − 367.000 3570 3495 97.90% 0.8% 2.1%
62 Numerex Corp 2010 4  − 2.412 57.146  − 4.22%  − 1.610 11.97 11.97 100.00% 13.5% 3.0%
63 Alaska Communications Systems Group, Inc 2011 2  − 12.045 615.631  − 1.96%  − 6.823 109.468 5.5 5.02% 46.4% 1.5%
64 Quidel Corporation 2003 3  − 1.376 86.866  − 1.58%  − 0.789 17.1 1.9 11.11% 39.0% 2.8%
65 Ribbon Communications, Inc 2017 2  − 5.180 292.353  − 1.77%  − 11.874 115.51 89.6 77.57% 0.0% 2.2%
66 AGCO Corporation 2006 4  − 171.400 4,114.500  − 4.17%  − 103.200 472.5 291.4 61.67% 0.0% 3.7%
67 Spectrum Brands Holdings, Inc 2015 3  − 98.200 7,472.200  − 1.31% 21.100 587.9 268.7 45.71% 0.0% 2.8%
68 AdStar, Inc., 2004 4  − 1.423 7.412  − 19.20%  − 2.206 5.72 5.72 100.00% 0.4% 1.1%
69 Symbol Technologies, Inc 2003 2  − 16.295 1,526.611  − 1.07% 8.770 532.069 43.936 8.26% 24.6% 5.6%
70 Convergys Corporation 2012 2  − 94.600 2,111.600  − 4.48%  − 64.200 147.2 19.7 13.38% 16.4% 4.4%
71 Salix Pharmaceuticals, Ltd 2011 4  − 27.000 1,312.969  − 2.06% 16.626 126.17 7.711 6.11% 0.0% 1.0%
72 SeaChange International, Inc 2015 4  − 20.024 177.669  − 11.27%  − 22.306 47.877 47.368 98.94% 0.1% 1.4%
73 AK Steel Holding Corporation 2005 4  − 78.500 5,487.900  − 1.43%  − 67.600 1666.8 35.2 2.11% 40.8% 26.6%
74 CRA International, Inc 2015 4  − 4.453 313.717  − 1.42%  − 2.553 33,866 4003 11.82% 0.0% 2.6%
75 Abeona Therapeutics, Inc 2016 4  − 1.200 111.058  − 1.08%  − 7.002 88.021 88.021 100.00% 0.0% 1.8%
76 AbbVie, Inc 2014 3  − 737.000 28,454.000  − 2.59% 687.000 2152 172 7.99% 26.3% 0.9%
77 The E. W. Scripps Company 2015 2  − 31.053 1,698.720  − 1.83%  − 19.494 134.204 2.334 1.74% 33.5% 1.9%
78 The Spectranetics Corporation 2009 2  − 1.152 105.611  − 1.09%  − 2.342 19.22 12.735 66.26% 1.7% 1.6%
79 Energy Focus, Inc 2016 4  − 0.857 34.978  − 2.45%  − 7.800 12.537 12.537 100.00% 0.0% 1.0%
80 Starwood Hotels & Resorts Worldwide, Inc 2009 4  − 376.000 8,761.000  − 4.29%  − 332.000 1350 482 35.70% 44.0% 3.3%
81 Visteon Corporation 2016 4  − 35.000 2,373.000  − 1.47% 34.000 1860 1532 82.37% 8.8% 2.5%
82 H.B. Fuller Company 2014 4  − 26.637 1,869.006  − 1.43% 21.726 104,360 16,364 15.68% 50.3% 2.3%
83 Lantronix, Inc 2016 2  − 0.286 27.091  − 1.06%  − 0.922 35.85 35.85 100.00% 0.0% 3.3%
84 Chemed Corporation 2007 2  − 13.715 779.532  − 1.76% 15.398 52.814 0 0.00% 38.7% 1.7%
85 Sykes Enterprises, Inc 2010 3  − 9.634 816.447  − 1.18% 16.567 114.128 60.091 52.65% 0.0% 1.6%
86 Giga-tronics, Inc 2012 3  − 0.099 9.309  − 1.06%  − 0.865 16.403 16.403 100.00% 0.0% 1.4%
87 MSA Safety, Inc 2017 2  − 32.219 1,362.036  − 2.37% 11.712 60.709 4.559 7.51% 0.0% 0.9%
88 Eli Lilly and Company 2004 4  − 524.000 24,867.000  − 2.11% 520.000 2714.4 508.4 18.73% 100.0% 35.2%
89 LoJack Corporation 2009 3  − 18.250 149.673  − 12.19%  − 19.681 25.828 8.137 31.50% 31.7% 1.7%
90 Lumber Liquidators Holdings, Inc 2017 1  − 18.000 478.996  − 3.76%  − 25.927 36.198 26.318 72.71% 0.0% 2.7%
91 Lawson Products, Inc 2013 4  − 2.401 159.945  − 1.50%  − 3.312 36.536 35.834 98.08% 0.0% 1.9%
92 Quixote Corporation 2006 4  − 15.618 125.203  − 12.47%  − 13.985 24.16 0.445 1.84% 34.8% 38.1%
93 Maxtor Corporation 2004 3  − 31.393 2,327.219  − 1.35%  − 96.446 479.873 181.295 37.78% 1.3% 3.1%
94 Rayonier Advanced Materials Inc 2015 2  − 26.660 1,260.984  − 2.11%  − 0.665 159.915 19.702 12.32% 52.9% 35.6%
95 Kendle International, Inc 2006 4  − 9.277 455.072  − 2.04%  − 6.961 27.689 7.67 27.70% 33.1% 1.6%
96 Telkonet, Inc 2007 4  − 2.472 38.741  − 6.38%  − 7.254 32.292 32.292 100.00% 0.0% 0.2%
97 Mattel, Inc 2017 3  − 74.242 6,199.684  − 1.20% 61.263 767.418 579.245 75.48% 100.0% 1.2%
98 Cytec Industries, Inc 2005 2  − 62.700 4,099.200  − 1.53%  − 3.600 338.2 23.2 6.86% 100.0% 33.3%
99 Limited Brands, Inc 2012 4  − 120.082 6,019.000  − 2.00% 710.410 370 171 46.22% 42.1% 35.1%
100 United Continental Holdings, Inc 2016 2  − 425.000 40,476.000  − 1.05% 931.000 6010 68 1.13% 36.8% 1.0%
  Mean     − 66.082 3,275.102  − 3.56% 16.926 2,104.591 606.593 42.13% 25.3% 9.1%
  Median     − 21.105 784.284  − 2.00%  − 3.248 114.819 23.400 21.26% 16.9% 2.5%
  Mean where VA% < 100% (79 obs)          26.75%   
  Mean where VA% < 95% (75 obs)          22.95%   
  1 st Qtr Obs   4          
  2 nd Qtr Obs   22          
  3 rd Qtr Obs   29          
  4 th Qtr Obs   45          

FYear Fiscal year from Compustat, Qtr Fiscal quarter from Compustat, NSI Total negative special items (SPIQ < 0) from Compustat, Assets Total assets (ATQ) from Compustat, NSI% NSI / assets, PTI Pre-tax income (PIQ) from Compustat, DTATotal deferred tax assets from the income taxes footnote in the 10-K (subsequent 10-K if interim quarter observation), VA The valuation allowance on the deferred tax assets from the income taxes footnote in the 10-K (subsequent 10-K if interim quarter observation), %VA VA / DTA, ETR total income tax expense (TXTQ) divided by pre-tax income (PIQ), MTR Firm-specific marginal tax rate provided by Graham (1996a, 1996b)

Panel B: Detailed examination of random sample of 25 firms where PSI ÷ Assets > 1.0%

# Company Name FYear Qtr PSI Assets PSI% PTI DTA VA %VA ETR MTR
1 Imperva, Inc 2017 1 34.279 446.726 7.67% 24.041 48.424 46.125 95.25% 4.0% 4.0%
2 Alico, Inc 2009 2 7.000 218.105 3.21% 4.034 9.926 0.651 6.56% 49.0% 2.5%
3 SMTC Corporation 2004 3 2.490 94.823 2.63% 2.983 68.410 68.410 100.00% 3.3% 1.1%
4 EnPro Industries, Inc 2010 2 45.000 1082.100 4.16% 70.200 96.500 6.900 7.15% 36.6% 1.5%
5 SigmaTel, Inc 2006 3 45.673 284.279 16.07% 29.017 9.436 1.270 13.46% 60.3% 0.8%
6 Maxygen, Inc 2010 4 20.000 146.986 13.61% 70.435 51.284 51.284 100.00% 1.3% 0.9%
7 Tiffany & Co 2007 3 95.051 3133.098 3.03% 151.479 272.825 21.035 7.71% 33.9% 0.9%
8 Landauer, Inc 2016 3 4.131 194.670 2.12% 10.804 30.745 0.456 1.48% 31.3% 4.4%
9 Harris Corporation 2007 3 118.100 3940.800 3.00% 272.100 200.400 167.900 83.78% 23.4% 1.2%
10 Best Buy Co., Inc 2013 2 225.000 13,284.000 1.69% 406.000 879.000 158.000 17.97% 41.2% 3.4%
11 Sento Corporation 2005 2 0.182 15.415 1.18% 0.316 4.630 4.619 99.76% 2.2% 14.5%
12 Louisiana-Pacific Corporation 2013 2 35.900 2571.900 1.40% 114.500 205.000 23.500 11.46% 20.5% 27.2%
13 Pixelworks, Inc 2008 3 7.992 92.887 8.60% 8.533 98.260 96.767 98.48% 3.7% 1.9%
14 AMREP Corporation 2017 1 1.318 105.808 1.25% 2.214 12.483 3.873 31.03% 34.6% 2.0%
15 Ballantyne Strong, Inc 2017 4 0.946 59.014 1.60%  − 0.324 12.924 12.317 95.30% 0.0% 0.9%
16 Con-way, Inc 2006 4 41.041 2301.889 1.78% 106.313 246.953 21.164 8.57% 21.4% 3.7%
17 Temple-Inland, Inc 2009 2 66.000 5802.000 1.14% 101.000 585.000 23.000 3.93% 34.7% 2.8%
18 TransAct Technologies Incorporated 2013 4 0.640 40.408 1.58% 1.405 3.038 0.242 7.97% 21.1% 33.2%
19 Sypris Solutions, Inc 2007 3 4.835 435.037 1.11% 3.236 25.886 0.000 0.00% 18.5% 6.1%
20 Allegheny Energy, Inc 2004 4 93.126 9045.140 1.03% 140.917 661.700 4.300 0.65% 38.7% 8.8%
21 I-trax, Inc 2003 3 0.500 13.887 3.60%  − 1.610 10.442 9.548 91.44% 0.0% 0.9%
22 Mercer International, Inc 2014 3 31.851 1547.916 2.06% 62.620 187.087 87.862 46.96% 0.0% 2.8%
23 IntriCon Corporation 2012 3 0.822 40.915 2.01% 0.281 8.753 8.746 99.92% 13.1% 16.0%
24 Globecomm Systems, Inc 2012 4 4.129 310.067 1.33% 9.126 11.214 2.850 25.41% 22.4% 3.1%
25 Tetra Tech, Inc 2014 4 23.816 1776.404 1.34% 22.646 50.879 7.576 14.89% 0.3% 6.6%
  Mean    36.393 1,879.371 3.5% 64.491 151.648 33.136 42.8% 20.6% 6.1%
  Median    20.000 310.067 2.0% 22.646 50.879 9.548 18.0% 21.1% 2.8%
  Mean where VA% < 95% (18 obs)          22.14%   
  1 st Qtr Obs   2          
  2 nd Qtr Obs   6          
  3 rd Qtr Obs   10          
  4 th Qtr Obs   7          

PSI Total positive special items (SPIQ > 0) from Compustat, PSI% PSI / Assets

Panel C : Detailed examination of random sample of 25 firms where |RC|÷ Assets > 1.0%

# Company Name FYear Qtr RC Assets RC% PTI DTA VA %VA ETR MTR
1 Lionbridge Technologies, Inc 2010 4 -1.881 156.976 -1.2% -2.468 109.480 107.957 98.61% 0.0% 35.2%
2 ParkerVision, Inc 2015 2 -0.313 13.334 -2.3% -4.842 122.152 122.152 100.00% 0.0% 0.5%
3 Vermillion, Inc 2017 4 -0.286 7.497 -3.8% -2.955 23.320 23.320 100.00% 0.0% 3.1%
4 NPS Pharmaceuticals, Inc 2006 2 -6.012 248.092 -2.4% -39.275 385.473 385.473 100.00% 0.0% 1.9%
5 Perry Ellis International, Inc 2016 2 -5.897 559.345 -1.1% -4.428 51.744 48.052 92.86% 19.5% 2.1%
6 Libbey Inc 2005 2 -6.411 625.850 -1.0% -1.293 52.459 3.033 5.78% 32.6% 7.6%
7 Tollgrade Communications, Inc 2006 3 -5.808 161.142 -3.6% -5.009 6.267 2.733 43.61% 35.1% 27.2%
8 Phoenix Technologies Ltd 2007 4 -1.036 94.480 -1.1% -0.668 43.779 43.549 99.47% 100.0% 1.0%
9 PowerSecure International, Inc 2007 2 -14.139 81.516 -17.3% -14.217 13.630 8.290 60.82% 0.0% 1.2%
10 MicroStrategy Incorporated 2014 3 -11.578 559.733 -2.1% -2.013 37.852 0.077 0.20% 58.0% 3.2%
11 Fair Isaac Corporation 2015 4 -15.986 1230.163 -1.3% 20.467 70.276 13.882 19.75% 3.2% 1.7%
12 SIFCO Industries, Inc 2017 3 -4.430 116.442 -3.8% -5.634 17.215 9.597 55.75% 0.0% 1.3%
13 Lexmark International, Inc 2009 4 -45.900 3354.200 -1.4% 82.200 213.800 0.200 0.09% 27.4% 4.9%
14 Endwave Corporation 2009 4 -1.196 77.116 -1.6% -3.515 74.554 74.554 100.00% 2.1% 2.5%
15 Network Equipment Technologies, Inc 2006 4 -10.187 134.019 -7.6% -9.490 81.421 81.421 100.00% 5.1% 1.4%
16 ARI Network Services, Inc 2010 4 -0.361 19.777 -1.8% -0.909 10.332 5.657 54.75% 100.0% 34.1%
17 CTS Corporation 2015 4 -9.522 484.133 -2.0% -0.679 96.797 10.266 10.61% 0.0% 34.1%
18 Tutogen Medical, Inc 2005 3 -1.600 29.719 -5.4% -1.344 8.420 5.865 69.66% 0.0% 2.0%
19 Actuant Corporation 2017 4 -118.774 1516.955 -7.8% -108.415 90.845 22.671 24.96% 8.9% 3.6%
20 Gateway, Inc 2004 3 -63.061 1825.875 -3.5% -58.250 589.778 517.348 87.72% 3.0% 0.9%
21 PMC-Sierra, Inc 2005 2 -7.606 455.174 -1.7% 2.655 377.735 377.735 100.00% 80.1% 3.0%
22 Zafgen, Inc 2016 3 -1.536 142.712 -1.1% -14.675 97.720 97.720 100.00% 0.0% 0.8%
23 Pemstar, Inc 2005 2 -7.893 371.345 -2.1% -13.207 68.193 62.992 92.37% 0.0% 2.8%
24 Sevcon, Inc 2013 2 -0.605 21.880 -2.8% -0.576 4.412 0.159 3.60% 100.0% 2.3%
25 Intrusion, Inc 2004 4 -0.139 5.316 -2.6% -0.788 31.508 31.508 100.00% 0.0% 0.0%
  Mean    -13.686 491.712 -3.3% -7.573 107.166 82.248 64.8% 23.0% 7.1%
  Median    -5.897 156.976 -2.1% -2.955 68.193 23.320 87.7% 3.0% 2.3%
  Mean where VA% < 95% (15 obs)          41.50%   
  1 st Qtr Obs   0          
  2 nd Qtr Obs   8          
  3 rd Qtr Obs   6          
  4 th Qtr Obs   11          

RC Total Restructuring Charges (RCPQ) from Compustat, RC% = RC/Assets

Appendix 3

Table 11

Table 16 Variable Definitions

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Cready, W.M., Lopez, T.J., Sisneros, C.A. et al. Empirical implications of incorrect special item tax rate assumptions. Rev Account Stud (2022). https://doi.org/10.1007/s11142-021-09661-1

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  • DOI: https://doi.org/10.1007/s11142-021-09661-1

Keywords

  • Special items
  • Nonrecurring items
  • Assumed tax rates
  • Marginal tax rates

JEL Classification

  • M40
  • M41
  • H25
  • H32