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Sharing Risk with the Government: How Taxes Affect Corporate Risk Taking

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Listed author(s):
  • Alexander Ljungqvist
  • Liandong Zhang
  • Luo Zuo

Abstract

Using 113 staggered changes in corporate income tax rates across U.S. states, we provide evidence on how taxes affect corporate risk-taking decisions. Higher taxes reduce expected profits more for risky projects than for safe ones, as the government shares in a firm’s upside but not in its downside. Consistent with this prediction, we find that risk taking is sensitive to taxes, albeit asymmetrically: the average firm reduces risk in response to a tax increase (primarily by changing its operating cycle and reducing R&D risk) but does not respond to a tax cut. We trace the asymmetry back to constraints on risk taking imposed by creditors. Finally, tax loss-offset rules moderate firms’ sensitivity to taxes by allowing firms to partly share downside risk with the government.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 21834.

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Length:
Date of creation: Dec 2015
Publication status: published as ALEXANDER LJUNGQVIST & LIANDONG ZHANG & LUO ZUO, 2017. "Sharing Risk with the Government: How Taxes Affect Corporate Risk Taking," Journal of Accounting Research, vol 55(3), pages 669-707.
Handle: RePEc:nbr:nberwo:21834
Note: CF
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Find related papers by JEL classification:

  • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
  • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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Cited by:

  1. Cen, Ling & Maydew, Edward L. & Zhang, Liandong & Zuo, Luo, 2017. "Customer–supplier relationships and corporate tax avoidance," Journal of Financial Economics, Elsevier, vol. 123(2), pages 377-394.

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