The Market Valuation of the Permanent Book-to-Tax Differences Generated by Stock-Based Compensation Awards

Abstract

ABSTRACT We examine the market valuation of the annual change in the additional paid-in capital (APIC) tax pool, a financial statement account that captures the permanent book-to-tax differences related to stock-based compensation awards. Evidence from prior compensation studies demonstrates that the tax deduction from the settlement of stock-based awards, rather than the recorded book expense, is the true economic cost of the awards. If this is true, then the APIC tax pool should be negatively related to firm value. Conversely, previous tax avoidance research suggests that this method of tax avoidance should be positively associated with firm value since it reduces cash tax payments. Using hand-collected data, we document a negative relation between the change in the APIC tax pool and cumulative abnormal returns surrounding the 10-K filing date. This result is consistent with the notion that investors use a tax-related financial statement account (i.e., the APIC tax pool) to incorporate the true economic cost of stock-based compensation awards into market values.