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

72 Pages Posted: 4 Jan 2016 Last revised: 27 Feb 2023

See all articles by Alexander Ljungqvist

Alexander Ljungqvist

Centre for Economic Policy Research (CEPR); Swedish House of Finance; European Corporate Governance Institute (ECGI)

Liandong Zhang

Singapore Management University - School of Accountancy

Luo Zuo

National University of Singapore; Cornell University

Multiple version iconThere are 4 versions of this paper

Date Written: December 2015

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.

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 2015). NBER Working Paper No. w21834, Available at SSRN: https://ssrn.com/abstract=2710466

Alexander Ljungqvist (Contact Author)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

European Corporate Governance Institute (ECGI)

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

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

National University of Singapore ( email )

Cornell University ( email )

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