The Influence of Bank Monitoring and Recognition of Deferred Tax Assets by Borrowing Korean Firms

Abstract

We investigate how bank monitoring influences the recognition of deferred tax assets by borrowing firms in Korea. We measure bank monitoring using bank loan amounts. Our sample consists of firms listed on the KOSDAQ and KOSPI in Korea from 2011 to 2022. We collect data on borrowing firms’ characteristics and bank loan amounts from TS-2000, KIS-VALUE, and DataGuide. Data on the recognition of deferred tax assets are collected by hand from DART annual reports. Our evidence supports the soft budget constraint hypothesis by demonstrating a positive relationship between bank monitoring and the recognition of deferred tax assets. However, we extend prior studies by showing that when bank monitoring is low, the relationship between bank monitoring and borrowers’ recognition of deferred tax assets is positive. In contrast, when bank monitoring is high, the relationship between bank monitoring and borrowers’ recognition of deferred tax assets is negative. Our results support the notion that the effect of bank monitoring on the recognition of deferred tax assets by borrowing firms cannot be explained by a simple linear relationship. Instead, the effect is characterized by a complex relationship within a relevant range. This supports both the soft budget constraint hypothesis and the bank monitoring hypothesis, suggesting that the relationship between banks and borrowing firms is complex and warrants careful examination.