Tax-Loss Carry Forwards and Firms' Risk
43 Pages Posted: 21 Jul 2016 Last revised: 25 Mar 2024
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: Suggested Citation