Tax-Loss Carry Forwards and Firms' Risk

43 Pages Posted: 21 Jul 2016 Last revised: 25 Mar 2024

See all articles by Jack Y Favilukis

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Ron Giammarino

University of British Columbia (UBC) - Sauder School of Business

Jose Pizarro

University of British Columbia (UBC) - Sauder School of Business

Date Written: July 20, 2016

Abstract

Tax loss carry forwards (TLCF), the accumulated corporate loss that can be applied to future taxable income, forms an important and risky corporate asset. We first show theoretically that a firm's TLCF are a complex contingent claim that affects equity risk: If TLCF are so low that they will be used with near certainty, equity risk is decreasing with TLCF because TLCF represent a safe cash flow. On the other hand, if TLCF are high, equity risk is increasing in TLCF because firms are more likely to see their TLCF left unused after negative cash flow shocks. Under reasonable conditions, the model predicts the latter to dominate, and for the relationship to be mostly increasing. Empirically, TLCF positively and significantly forecast measures of equity risk, as well as future returns controlling for standard risk measures, indicating that TLCF are risky for the typical firm.

Keywords: Tax-Loss Carry Forward, Risk, Equity Returns

JEL Classification: G10, G12, G30, G32

Suggested Citation

Favilukis, Jack Y and Giammarino, Ronald and Pizarro, Jose, Tax-Loss Carry Forwards and Firms' Risk (July 20, 2016). Available at SSRN: https://ssrn.com/abstract=2812410 or http://dx.doi.org/10.2139/ssrn.2812410

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Ronald Giammarino (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver BC V6T 1Z2
Canada
604-822-8357 (Phone)
604-822-4695 (Fax)

Jose Pizarro

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

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