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

72 Pages Posted: 20 Dec 2015 Last revised: 1 Jan 2017

See all articles by Alexander Ljungqvist

Alexander Ljungqvist

Centre for Economic Policy Research (CEPR); Stockholm School of Economics; European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

Liandong Zhang

Singapore Management University - School of Accountancy

Luo Zuo

Cornell University - Samuel Curtis Johnson Graduate School of Management

Multiple version iconThere are 4 versions of this paper

Date Written: December 6, 2016

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.

Keywords: Risk taking, corporate taxes

JEL Classification: G32, H32

Suggested Citation

Ljungqvist, Alexander and Ljungqvist, Alexander and Zhang, Liandong and Zuo, Luo, Sharing Risk with the Government: How Taxes Affect Corporate Risk Taking (December 6, 2016). Journal of Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2705788 or http://dx.doi.org/10.2139/ssrn.2705788

Alexander Ljungqvist (Contact Author)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Stockholm School of Economics ( email )

111 60 Stockholm
Sweden

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

Liandong Zhang

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

HOME PAGE: http://accountancy.smu.edu.sg/faculty/profile/150531/Liandong-ZHANG

Luo Zuo

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

349 Sage Hall
Ithaca, NY 14853
United States
607-255-4002 (Phone)

HOME PAGE: http://www.johnson.cornell.edu/faculty-research/faculty/lz352/

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