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Taxation and systematic risk under decreasing returns to scale

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  • Lund, Diderik

    (Department of Economics, Copenhagen Business School)

Abstract

Lund (2002a) showed in a CAPM-type model how tax depreciation schedules affect required expected returns after taxes. Even without leverage higher tax rates implied lower betas when tax deductions were risk free. Here they are risky, and marginal investment is taxed together with inframarginal in an analytical model of decreasing returns. With imperfect loss offset tax claims are analogous to call options. The beta of equity is still decreasing in the tax rate, but increasing in the underlying volatility. The results are important if market data are used to infer required expected returns, and in discussions of tax design.

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Bibliographic Info

Paper provided by Copenhagen Business School, Department of Economics in its series Working Papers with number 02-2003.

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Length: 50 pages
Date of creation: 02 Jun 2006
Date of revision:
Handle: RePEc:hhs:cbsnow:2003_002

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Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark
Phone: 38 15 25 75
Fax: 38 15 26 65
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Web page: http://www.cbs.dk/departments/econ/
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Keywords: Corporate tax; depreciation; imperfect loss offset; decreasing returns; cost of capital; uncertainty;

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References

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  1. Shanker, Latha, 2000. "An innovative analysis of taxes and corporate hedging," Journal of Multinational Financial Management, Elsevier, vol. 10(3-4), pages 237-255, December.
  2. Lund, Diderik, 2006. "Valuation, leverage and the cost of capital in the case of depreciable assets," Working Papers 03-2003, Copenhagen Business School, Department of Economics.
  3. Lund,D., 2001. "Taxation, uncertainty, and the cost of equity for a multinational firm," Memorandum 13/2001, Oslo University, Department of Economics.
  4. Lawrence H. Summers, 1988. "Investment Incentives and the Discounting of Depreciation Allowances," NBER Working Papers 1941, National Bureau of Economic Research, Inc.
  5. Diderik Lund, 2002. "Petroleum Tax Reform Proposals in Norway and Denmark," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 37-56.
  6. Diderik Lund, 2002. "Taxation, Uncertainty, and the Cost of Equity," International Tax and Public Finance, Springer, vol. 9(4), pages 483-503, August.
  7. Jeremy I. Bulow & Lawrence H. Summers, 1984. "The Taxation of Risky Assets," NBER Working Papers 0897, National Bureau of Economic Research, Inc.
  8. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
  9. Roger H. Gordon & John D. Wilson, 1990. "Measuring the Efficiency Cost of Taxing Risky Capital Income," NBER Working Papers 1992, National Bureau of Economic Research, Inc.
  10. McDonald, Robert & Siegel, Daniel, 1984. " Option Pricing When the Underlying Asset Earns a Below-Equilibrium Rate of Return: A Note," Journal of Finance, American Finance Association, vol. 39(1), pages 261-65, March.
  11. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  12. Benninga, Simon & Sarig, Oded, 2003. "Risk, returns, and values in the presence of differential taxation," Journal of Banking & Finance, Elsevier, vol. 27(6), pages 1123-1138, June.
  13. Fane, G., 1987. "Neutral taxation under uncertainty," Journal of Public Economics, Elsevier, vol. 33(1), pages 95-105, June.
  14. Gordon A. Sick, 1990. "Tax-Adjusted Discount Rates," Management Science, INFORMS, vol. 36(12), pages 1432-1450, December.
  15. Hall, Robert E & Jorgenson, Dale W, 1969. "Tax Policy and Investment Behavior: Reply and Further Results," American Economic Review, American Economic Association, vol. 59(3), pages 388-401, June.
  16. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  17. Levy, Haim & Arditti, Fred D, 1973. "Valuation, Leverage, and the Cost of Capital in the Case of Depreciable Assets," Journal of Finance, American Finance Association, vol. 28(3), pages 687-93, June.
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Cited by:
  1. Lund, Diderik, 2006. "Valuation, leverage and the cost of capital in the case of depreciable assets," Working Papers 03-2003, Copenhagen Business School, Department of Economics.

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