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The role of taxes in early debt retirement
... 0. We exclude DNI in the regression for the 8-K window, as earnings are not yet available at the time of the 8-K release. Manzon (1994) identifies high-leverage and high-interest burden as motivations to retire debt early. Hence, we include the level of debt (DEBT), change in debt (DDEBT), and change in interest expense (DINT) in our regression. ...
... DINT is lagged quarterly change in total interest expense scaled by lagged market capitalization. Manzon (1994) also shows that firms with higher marginal tax rates are less likely to retire debt because of the greater value of the debt tax shield. Thus, we include MTR, the firm-specific marginal tax rate as estimated by Graham and Mills (2008). ...
... Thus, we include MTR, the firm-specific marginal tax rate as estimated by Graham and Mills (2008). 11 In addition, since Manzon (1994) demonstrates that growing firms are less likely to retire debt, we control for sales growth (SGR), defined as sales growth rate between current quarterly sales (SALEQ) and quarterly sales from four quarters prior. 12 Since companies in financial distress are less likely to early retire debt, we include the Altman Z-Score (ZSCORE), in Equation (1). ...
Does the placement of a line item in the income statement matter to investors? The passage of Statement of Financial Accounting Standards (SFAS) No. 145 (Financial Accounting Standards Board [FASB] 2002) affords a quasi-experimental setting to answer this question, because pre-SFAS No. 145, gains/losses from early debt extinguishments were reported below the line, while post-SFAS No. 145, they were reported above the line. After controlling for other identified changes that occur during our sample period, we find that, pre-SFAS No. 145, the market does not respond to these gains/losses, whereas post-SFAS No. 145, it does. This suggests that the market response to gains/losses is associated with their placement in the income statement. Our findings contribute to the literature on the importance of income statement presentation by demonstrating that a line-item position in the income statement has important valuation implications.
JEL Classifications: G12; G14; M41.
... Second, the professor might relax the current dividend assumption, follow the diagram approach to calculate the MTR assuming foreign profits are not immediately remitted, and use the future dividend model in Eq . (16) Manzon (1994) and Scholes and Wolfson (1989), the results show that firms with high marginal tax rates are more likely to announce stock buybacks than firms with low marginal tax rates . Additionally, firms that announce stock buybacks have lower debt-equity ratios than firms that do not announce buybacks . ...
... Scholes and Wolfson (1989) suggest that capital structure decisions are based on both tax and non-tax factors . Other prior studies have examined capital structure decisions in light of a firm choosing to issue either additional debt or equity securities (Mackie-Mason, 1990 ;Manzon, 1994 ;Carter & Manzon, 1995) . These studies conclude that tax considerations do affect the proportion of debt the firm carries such that firms with higher tax costs tend to have a greater proportion of debt than do firms with lower tax costs . ...
... tax laws for investment-related tax shields to lead to the loss of the deductibility of debt-related tax shields . Manzon's (1994) results suggest that firms with low marginal tax rates that retire debt tend to reduce their firms' leverage to a greater degree than do firms with high marginal tax rates . Carter and Manzon (1995) found that firms with low marginal tax rates were more likely to issue equity than debt as compared to firms with high marginal tax rates . ...
The replacement of the book-income adjustment (BIA) component of the corporate alternative minimum tax (AMT) formula with the adjusted current earnings (ACE) component in 1990 increased the effective tax rate on interest income from municipal bonds and lowered the yield on municipal bonds relative to taxable bonds. This study assesses the effects of the replacement of the BIA with the ACE on municipal bond holdings for a sample of 72 banks over the 1987–1993 period. Results show that banks that were likely to pay the AMT held significantly lower amounts of municipal bonds in the period following the enactment of the ACE adjustment than banks that were likely to pay the regular tax.
... A description of the sampling methodology can be found in U.S. Internal Revenue Service (1995). 7 See Dworin (1985) and Manzon andPlesko (1996, 2002) for discussions of consolidation issues. 8 Approximately 2% of the financial statement-based tax rates fell outside this range. ...
... This methodology was extended by Graham (1996a, b) in the context of determining the tax savings from capital structure choices. Manzon (1994) takes a simpler approach, and assumes profitable firms face the statutory maximum rate, but that those with losses face a reduced tax rate, based upon the time horizon over which the loss is expected to reverse. Rather than perform extensive simulations, as done by Shevlin and Graham, Manzon estimates the number of years it would take the firm to use up all of its NOL carryforwards, and uses that value to discount the tax rate. ...
... Plesko (1998) used marginal tax rates at the industry level to examine leverage decisions surrounding the Tax Reform Act of 1986. 15 A hybrid approach is suggested by Manzon and Shevlin (1995) who argue that for NOL carryforward firms the market value approach of Manzon (1994) provides a less biased and more accurate estimate of tax rates than the simulation approach. 16 Graham (1996b) and Shevlin (1999) both point out the ''true'' MTR is unobserved. ...
This paper examines the ability of financial statement measures of average and marginal tax rates (MTR) to capture tax attributes utilizing firm-level tax and financial data. The results suggest commonly used average tax rate measures provide little insight about statutory tax burdens, and may introduce substantial bias into analyses of tax incidence. Financial statement-based proxies for MTR, particularly those based on simulation methods, are found to perform well in estimating current year tax rates. Both current year and present value MTR are found to be highly correlated with an easily constructed binary proxy of firms’ tax status.
... Prior studies have considered the amount and type of missing data in Compustat tax variables, including firms' tax loss carryforward information. Manzon (1994)'s inspection of tax footnotes of firms with missing Compustat TLCFs or TLCFs equal to zero reveals that these firms regularly do have a TLCF. He finds that in his sample of 341 observations these data were incorrectly displayed in 3.8% of the cases. ...
... Although our method shows a large and important reduction in measurement error, we acknowledge that the information is still not perfect. Estimating taxable income based on financial reporting data in Compustat is imperfect, and earlier research indicates that TLCF information that is incorporated in Compustat also sometimes contains errors (Kinney & Swanson, 1993;Manzon, 1994). Also, we do not consider the effects of the Alternative Minimum Tax (AMT). ...
The ability to reduce current and future taxable income with prior years' taxable losses is highly relevant for explaining firms' effective tax rates. Compustat data on the tax loss carryforward (TLCF) are, however, often missing. We propose a method to estimate values for the missing TLCF data instead of the common practice in the literature of imputing zero values. In order to assess the accuracy of our method, we compare our estimated TLCFs with both a random selection of 10-K data and Compustat data for firm-years where Compustat data is available. The results show that our estimated values align very closely with the reported data. We re-analyze two existing studies using these estimated values. With the first, we show that imputing our estimated values instead of zeros leads to a large decrease in measurement error. This reduces the risk that firms with missing data and low effective tax rates are incorrectly classified as tax aggressive. The second re-analysis shows that using our estimated TLCFs leads to economically and statistically different conclusions compared to imputing zeros. Using our estimated values thus increases the probability of correct inferences in studies that use Compustat TLCF data. The estimated values are available from https://doi.org/10.34894/N9J1WE.
... We continue in the direction of recent work by Plesko (2001), who uses a single-year tax return benchmark to evaluate alternative corporate tax measures, but in a setting where we have multiple years of tax return data to consider the effects of NOL carryback and carryforward provisions. We build on prior studies that develop and compare corporate tax measures (see, e.g., Shevlin 1990, Manzon 1994, Graham 1996b, Shevlin 1999, and Plesko 2001 by evaluating how well Compustat NOL data (item #52) 1 Tests of firms' tax incentives have also played an important role in studies of regulated industries that consider the combined effects of taxes and regulatory requirements (e.g., Scholes et al. 1990, Beatty et al. classifies firms as having tax-loss carryovers. We identify sources of misclassification error and investigate the effectiveness of suggested data screens in reducing error rates. ...
... Compustat NOL carryforward field. In his study of early debt retirements, Manzon (1994) also finds that Compustat incorrectly reported NOLs as missing or zero for 3.8% of his sample. ...
Although Compustat net operating loss (NOL) data are an underlying component of most proxies of corporate tax incentives, there is little empirical evidence regarding how Compustat NOLs relate to firms' tax-loss positions per their U.S. tax returns. We use confidential U.S. tax return data for a sample of large corporations over the period 1981–1995 to compute firms' U.S. tax-loss carryovers and construct a matched sample with Compustat data. We then evaluate how well Compustat NOL data works as an indicator of firms' U.S. tax-loss positions, identify sources of misclassification errors, and investigate the effectiveness of using additional Compustat data screens. We find that screening for U.S. current income tax or total pretax income successfully reduces certain types of misclassification errors. We conclude that care should be used in constructing U.S. tax-loss proxies, particularly when the research setting involves firms with foreign operations or corporate acquisitions activity.
... The simulated tax rate captures the effect of future carrybacks because it forecasts the probability of future tax losses that can be carried back to obtain a refund on taxes paid today. Manzon (1994) proposes a tax rate that captures some of the advantages of the simulated marginal tax rate but is easier to calculate. The Manzon tax rate equals the top statutory tax rate for profitable firms. ...
... Graham (1996b) demonstrates that the simulated marginal tax rate is the best available tax rate in a tax system (like that in the US) that allows firms to carry forward and carry back tax-losses. In contrast, Graham finds that the Manzon (1994) tax rate is a poor variable in such an environment. The shortcoming of the Manzon tax rate is that it does not anticipate the probability of future losses that can be carried back to offset current period taxes. ...
The paper investigates determinants of capital structure, focusing on tax incentives for debt. The paper makes use of a panel of Australian firms in two tax regimes: a classical regime, and a dividend imputation regime. An important feature is the identification of the economic model using Bayesian selection methods. This methodology offers a new way of examining and assessing interactions between variables where there are competing explanations, noisy data and no unifying theory. As hypothesized, the results demonstrate a significant tax coefficient during the classical era and an insignificant tax coefficient in the imputation era. Risk and signalling variables, represented by firm size, Z-score, operating risk and asset base are also found to help explain capital structure choice.
... In addition, the tax authority is not attempting to restrain firms from undertaking such inter-company asset transfers. Therefore, firms can be expected to implement such widely known tax planning measures in a timely manner to maximize the present value of Manzon (1994). It is computed by discounting the statutory tax rate at the average bond rate over n periods, where n is the number of years required to earn the equivalent of loss carryforward balances assuming positive annual earnings accrue at the average bond rate. ...
... This data-intensive algorithm would be of limited application if the resulting simulated marginal tax rates were highly correlated to simple measures or proxies of firms' taxpaying status. Other proxies for firms' taxpaying status used in the literature include an indicator variable for loss carry-forwards (LOSS), a trichotomous variable described in Graham (1996a) (TRICH), Manzon's measure (MANZON) described in Manzon (1994), average tax rates (AVG), and statutory tax rates (STR). Table 1 presents the correlations between these commonly used proxies for firms' taxpaying status. ...
... Graham's (1996aGraham's ( , 1996b simulated MTR uses the entire NOL carryback/carryforward schedule (18 years). However, Graham gathers NOL information from Compustat and studies show that Compustat NOL data contains certain inaccuracies(Kinney and Swanson, 1993;Manzon, 1994).Mills, Newberry, and Novack (2003) fi nd that u sing additional Compustat data for U.S. current income tax expense reduces the error related to Compustat's reporting of an NOL carryforward where no U.S. tax NOL exists. ...
This study examines the availability and incentive effects of the Research and Experimentation tax credit following structural changes in the computation of the credit enacted in the Omnibus Budget Reconciliation Act of 1989 (OBRA89). We find that overall firm eligibility declined after OBRA89, but eligibility increased for firms in high-tech industries, relative to firms in other industries. Dynamic panel regressions indicate that median research and development spending intensity of high-tech (other) firms increased by approximately 15.9 (9.4) percent from 1986-1989 to 1990-1994. For firms that qualified for the credit, our estimates imply approximately $2.08 of additional research and development spending per dollar of revenue forgone.
... Kinney and Swanson (1993) report that, in a sample of 266 firm-years, there are 28 cases in which tax loss carryforwards are missing in COMPUSTAT but a carryforward for tax purposes is reported in the tax footnote, and 5 cases in which tax loss carryforwards are populated in COMPUSTAT but there is no carryforward at all reported in the tax footnote. Manzon (1994) reports similar error rates. Mills, Newberry and Novack (2003) recommend considering firms to have carryforwards only if COMPUSTAT reports a positive carryforward balance and no U.S. current income tax. ...
Existing literature focuses on how corporate taxation affects firms' investment decisions by altering after-tax returns. This paper instead examines how corporate taxation affects investment by reducing the cash flow a firm has available to invest in the current period. I use a sharp nonlinearity in the mapping from pre-tax profitability to taxes created by the tax loss carryforward feature of the tax code to identify the cash flow effect of taxes. The results indicate that firms reduce investment when they pay more taxes, especially when unfavorable capital market conditions create a greater dependence of investment on internal sources of cash.
... However, one problem with using MTRs in predicting economic decisions is that MTRs are generally unobservable. Therefore, the tax literature has developed proxies for MTR (e.g., Shevlin 1990; Manzon 1994; Graham 1996a; Geisler and Larkins 2002). Graham and Mills (2008), Graham (1996b), Pattenden (2002), and Plesko (2003) find that Graham's simulated ...
Due to the complexity of the alternative minimum tax (AMT), marginal tax rates (MTR) estimation studies deem AMT firms’ MTRs almost impossible to estimate. We develop an analytical model for estimating AMT firms’ MTRs. The model shows that AMT firms’ MTRs are essentially the opportunity cost of AMT payments: it is a rate of return weighted average of the firm’s effective tax rate and the statutory AMT rate. Retests utilizing AMT MTRs, instead of the traditional MTRs, for AMT firms in two prior empirical studies reveal improved statistical significance of the MTR coefficient. The impact of applying AMT MTR in empirical estimates may depend on the proportion and characteristics of AMT firms in the sample.
... Previous research has found significant relationships between ETRs and firm leverage and between ETRs and capital intensity (Stickney and McGee 1982;Gupta and Newberry 1997;Mills, Erickson, and Maydew 1998). Inclusion of these control variables does not change the sign or significance level of any of the estimated coefficients in Tables 4, 5, or 6. Thomas (1988), Scholes, Wilson, and Wolfson (1990), Shevlin (1990), Wang (1991), Manzon (1994), and Graham (1996) document the importance of controlling for NOLs when estimating marginal and average ETRs. Table 7 presents results of regressions of (2), which include controls for NOL carryforwards and the change in NOL carryforwards. ...
This paper investigates whether economies of scale exist for tax planning. In particular, do larger, more profitable, multinational corporations avoid more taxes than other firms, resulting in lower effective tax rates? While the empirical results indicate that, ceteris paribus, larger corporations have higher effective tax rates, firms with greater pre‐tax income have lower effective tax rates. The negative relation between effective tax rates (ETRs) and pretax income is consistent with firms with greater pre‐tax income having more incentives and resources to engage in tax planning.
Consistent with multinational corporations being able to avoid income taxes that domestic‐only companies cannot, I find that multinational corporations in general, and multinational corporations with more extensive foreign operations, have lower worldwide ETRs than other firms. Finally, in a sample of multinational corporations only, I find that higher levels of U.S. pre‐tax income are associated with lower U.S. and foreign ETRs, while higher levels of foreign pre‐tax income are associated with higher U.S. and foreign ETRs. Thus, large amounts of foreign income are associated with higher corporate tax burdens. Overall, I find substantial evidence of economies of scale to tax planning.
... 2. EARN Earnings before endogenous items computed as total earnings before federal income taxes and dividends to policyholders plus the life insurance policy reserve provision less net commissions and expenses from reinsurance ceded less realized capital gains, collected from the Summary of Operations (Accrual Basis) and Capital Surplus Account tables in Best's. Manzon [1994]: ...
This study investigates whether the form of ownership in the life insurance industry (i.e., public, private or mutual) affects the pursuit of capital, earnings, and tax management goals between 1975 and 1991. Results indicate that differences resulting from ownership structure are most pronounced in the area of tax planning. Private stock companies use both policy reserves and reinsurance to manage taxes while public companies, on average, do not appear to manage taxes. I investigate whether the tax planning differences observed appear to be induced by compensation schemes used to control agency costs in public firms, or concerns with stock market interpretations, by studying the tax planning behavior of mutual firms. These firms have diffuse ownership structures, similar to those of public companies, and thus face similar agency problems. But since mutual firms are owned by their policyholders, they are not subject to the stock market concerns that affect public companies. If both private stock and mutual firms manage taxes more aggressively than public companies, the inference is that stock market concerns create the behavioral differences. However, if only private stock companies are aggressive tax managers, differences are more likely to stem from agency costs. My results indicate that mutual firms, like public companies, do not, on average, manage taxes. This outcome is consistent with incentive compensation contracts, designed to control agency costs, at least partly inducing differences in tax management behavior between private and public stock companies. I find support for capital management in all ownership structures. However, the specific tools employed vary across firm type. Private stock companies are more likely to manage capital through adjusting dividends while public companies and mutual firms are more likely to vary reinsurance levels. Mutual firms also used realized gains and losses to manage capital. All firm types appear to use policy reserves and reinsurance to smooth earnings.
... Forecasts of future taxable income are needed to estimate the number of years before the NOL is exhausted. Manzon (1994) forecasts future taxable income with a simple valuation model: ...
This paper traces the development of archival, microeconomic-based, empirical income tax research in accounting over the last 15 years. The paper details three major areas of research: (i) the coordination of tax and non-tax factors, (ii) the effects of taxes on asset prices, and (iii) the taxation of multijurisdictional (international and interstate) commerce. Methodological concerns of particular interest to this field also are discussed. The paper concludes with a discussion of possible directions for future research.
We show that, for a firm facing a high marginal tax rate, the benefit of using debt relative to managerial ownership to control agency costs increases at a decreasing rate. Debt and managerial stock ownership represent alternative mechanisms for reducing agency costs of the relationship between owner-investors and managers in firms. However, although debt and managerial ownership provide overlapping benefits, only debt can provide the differential benefit of reducing the firm’s tax liability. While the tax benefit from using debt relative to managerial ownership to control agency conflicts is an increasing function of the firm’s marginal tax rate, the decreased managerial ownership results in external investors bearing a larger part of the cost of debt that accrues to the firm. Effectively, for external investors, the relative cost of debt decreases at a decreasing rate when the marginal tax rate increases. Therefore, the trade-off between debt and managerial ownership predicted by the agency literature is expected to be strong at low marginal tax rates, but get progressively weaker at higher marginal tax rates. In this paper, we build an analytical model of this hypothesis and provide strong empirical evidence in its support. Our study contributes to a further understanding of how tax rates might affect the interaction of capital structure decisions with the incentive compatibility issues and corporate governance. The study also provides a basis for future studies to examine factors other than tax rates that differentially affect debt and managerial ownership costs.
Changes in the statutory corporate income tax rate provide firms with an opportunity to reduce their tax burden by shifting their taxable income from higher to lower tax rate years. One negative consequence of shifting taxable income across years is higher variation in book income for financial reporting purposes. Taxable income and book income are closely related in most countries, and, in general, reporting volatile book income across years is not a favorable signal to investors. This study investigates how firms shift taxable income and concurrently mitigate book income fluctuation by managing accrual components separately when the statutory income tax rate changes. Unlike prior studies, we decompose discretionary accruals into two components and examine distinctive patterns of accrual management in Korea, where book-tax conformity is high and aggressive tax avoidance is restricted. We find that firms manage book-tax accruals for taxable income shifting and manage book-only accruals to mitigate book income fluctuation. Furthermore, we find the extent of book-tax and book-only accruals management varies depending on the firms' tax and financial reporting costs. The results of this study provide clear and compelling evidence of firms' opportunistic accrual management behavior in response to statutory tax rate reduction.
Managers frequently encounter situations involving a trade-off between financial reporting and tax reporting incentives. This paper examines whether inside ownership concentration, a proxy for reduced capital market pressure, influences the balance of these two opposing external reporting incentives. The empirical tests use a sample of major asset divestitures to show that, for high tax-rate firms, managers of firms with lower levels of inside ownership concentration realize larger gains or smaller losses, on average. This work extends previous research by combining insights from the micro-economics tax incentives literature and financial reporting incentives literature, and by considering explicitly the effect of a firm-specific variable on the balance between these two incentives.
This paper examines whether characteristics of Canadian firms can explain the observed difference in the use of LIFO for valuing inventory between the U.S. and Canada. Characteristics that help explain the choice between LIFO and FIFO use in the U.S. are used to compare Canadian firms to U.S. LIFO users and FIFO users separately. If Canadian firms are characteristically similar to U.S. FIFO users, then the firm characteristics hypothesis would be supported and LIFO would be infrequently used in Canada because few firms are LIFO-like in their underlying characteristics. Univariate nonparametric tests are used to compare U.S. and Canadian firms in the same industries on both an unmatched and matched basis. The results of this comparison indicate that Canadian average cost firms have more characteristics in common with U.S. LIFO users than FIFO users and Canadian FIFO firms have characteristics like both U.S. FIFO and U.S. LIFO firms. Logit models were estimated using the U.S. firms. These models predict that between three and 28% of Canadian firms would use LIFO. Thus, the firm characteristics explanation for infrequent use of LIFO in Canada is not supported by the data. These results imply that several Canadian firms may use LIFO if the institutional setting in Canada was more like that in the U.S.
With repeal of the extraterritorial income exclusion expected in 2004, many U.S. companies selling abroad must rethink tax strategies related to export profit. Many firms with net operating loss (NOL) carryforwards, foreign tax credit (FTC) carryforwards, and interest-charge domestic international sales corporations (ICDs) can reduce marginal tax rates (MTRs) below rates otherwise applying to domestic sales. This article provides several case examples illustrating how U.S. exporters can minimize the MTR applicable to export profit. MTRs often depend on the period over which the company expects to absorb its NOL or FTC carryforward, the firm’s discount rate, and, in the case of ICDs, the prevailing T-bill rate. Assuming a 34% corporate tax rate, exporters with NOL (FTC) carryforwards can reduce the MTR on export profit to zero (17%) in some cases. Also, over the range of variables this article examines, the ICD reduces the MTR on export profit to between 34 and 21%. The cases illustrate how NOL and FTC carryforwards and ICDs affect exporters’ MTRs and provide educators with useful tools for discussing the tax aspects of exporting.
This study examines whether there is a tax incentive for firms to engage in stock buybacks. Using methods previously established by Manzon (1994) and Scholes and Wolfson (1989), the results show that firms with high marginal tax rates are more likely to announce stock buybacks than firms with low marginal tax rates. Additionally, firms that announce stock buybacks have lower debt-equity ratios than firms that do not announce buybacks. Tax considerations do not appear to be a factor in the acquisition technique used, open market or tender offer. However, the tax motive and limited investment alternatives appear to be the major explanatory variables in the stock buyback decision.
caused by Debt and Provisions? In this paper the performance of a sample of German companies is measured by comparing the initially invested capital adjusted for cost of capital, dividends paid, share repurchases and equity raised with the market value at the end of the holding period. All possible holding periods between 1987 and 2000 are covered. The sample is subdivided into companies listed in the DAX-, MDAX- and SMAX-index. Performance is measured based upon the actual capital structure (levered performance) and also after assuming the company is financed by equity entirely (unlevered performance). It can be shown that tax shields on debt and provisions contribute considerably to levered performance. This applies especially to the subsample of DAX companies. These tax effects turn value decreasing holding periods into value increasing holding periods for a number of cases. If the tax disadvantage on bond income as in Miller (1977) is considered, tax effects of debt financing are close to zero or are even negative depending upon the level of tax free capital gains assumed. Tax shields on provisions exceed tax shields on debt quite regularly.
Graham (1996b) tested proxies for the marginal tax rate and derived a number of important results. This paper re-examines two factors raised by Graham's work: the impact of tax regulations on proxy performance, and the presence of bias in proxy construction. Simulation methods create a simple tax world where the 'true' marginal tax rate is known. Tax proxies are ranked against this rate using regression diagnostics. Manzon's proxy is the best performing of the simple tax proxies tested and is an unbiased estimate of the underlying tax process. The impact on proxies of tax loss treatments is assessed. Evidence is found that proxies differ in performance across different loss treatments. Evidence is found of an inbuilt preference between some variants of a simulated tax proxy and the tax benchmark.
Two separate streams of research find evidence that firms decrease R&D spending to meet earnings benchmarks and that the R&D tax credit increases R&D spending. However, these studies do not consider stock option exercises by R&D employees which likely influence R&D spending decisions because they increase R&D tax credits without reducing reported earnings. This study extends both areas of research by incorporating R&D tax credits from stock option exercises into the R&D spending decision. We find evidence that firms reduce R&D spending by 0.46 percent of total assets to avoid earnings decreases, but R&D tax credits generated by stock option exercises offset this decrease by 16 percent on average and up to 42 percent for a fully taxable firm. The results of this study suggest that the tax benefits of R&D-related stock option exercises are important considerations in studies that investigate myopic R&D investment and in studies that investigate the effect of the R&D tax credit on R&D spending.
The U.S. R&D credit has always been incremental in nature, providing a credit for qualified R&D expenses exceeding some base amount. Originally, the base amount was the average of the previous three years’ R&D expenses (i.e., a moving average). After heavy criticism that the credit’s incentive effects were largely offset in the following three years, Congress substituted the moving average base with a fixed-base as part of the Omnibus Budget Reconciliation Act of 1989. This study examines the effect of this structural change on the number of firms that are eligible for the credit and the type of firms that are eligible for the credit. In addition, we examine the incentive effect of the R&D tax credit for firms that qualified for the credit, and whether the incentive effect changed after the implementation of OBRA89. Using data from 1981-1994, we find overall firm eligibility declined after OBRA89, but increased for firms belonging to high-tech industries, relative to firms belonging to other industries. Dynamic panel regressions that control for various non-tax factors indicate that median R&D spending intensity of high-tech (other) firms increased approximately 15.9 (9.4) percent from 1986-1989 to 1990-1994. For qualified firms, our estimates imply approximately $2.08 of additional R&D spending per revenue dollar forgone.
This paper estimates the magnitude of tax costs and their impact on the decision to divest assets via a taxable sale rather than a tax-free spin-off. We find that the tax costs are substantial, averaging 8% of market value of the divested assets, and that cross-sectional variation in tax costs has a large impact on managers’ choice of divestiture method. Our results are consistent with two explanations. First, managers are willing to incur avoidable tax costs to gain earnings and cash flow benefits. Second, managers choose taxable sales because the acquisition premia on the sales exceed the avoidable tax costs.
This paper focuses on how best to measure the corporate marginal tax rate, which is an important input into financial analysis of the cost of capital, financing policy, corporate hedging, and corporate reorganizations. The results indicate that the simulated tax rate used by Shevlin (1990) and Graham (1996), although difficult to calculate, is the best available proxy for the ‘true’ marginal tax rate. If the simulated rate is unavailable, an easy-to-calculate trichotomous variable or the statutory marginal tax rate (which captures the progressivity in the tax schedule) are reasonable alternatives, better than most commonly used tax variables.
In this study we examine the effect of firms' marginal tax rates on incremental and overall reliance on mandatorily redeemable preferred stock (MRPS). Similarities in the cash flows associated with debt and MRPS, as well as similarities in the claims of holders of debt and MRPS on the assets of issuing firms, suggest that MRPS may be viewed as a substitute for debt. However, important differences in the tax treatment of MRPS and debt suggest that firms that cannot make full use of interest tax shields may be able to finance more efficiently using MRPS instead of debt. The results indicate that, both incrementally and overall, firms with low marginal tax rates rely more heavily on MRPS than debt relative to firms with high tax rates. This finding is consistent with the proposition that firms that cannot make full use of interest tax shields finance incrementally using equity rather than debt.
We examine the effect of marginal tax rates on the decision to retire debt early. Other factors that have been linked to the debt retirement decision are also investigated, including leverage adjustment and the value associated with the immediate recognition of a loss for tax purposes on early retirement. Results indicate that firms that retire debt early have lower marginal tax rates than firms that do not retire debt early. This finding is consistent with the proposition that firms are motivated to retire debt early by an incentive to reduce tax shields that cannot be used efficiently. Further, firms that retire debt early are more highly leveraged than firms that do not retire debt early. Evidence also suggests that some firms retire debt early at a loss to reduce currently taxable income.
I investigate the relation between conservatism and book-tax differences (BTDs), where "conservatism" refers to conservatism in the financial statement context (as opposed to the taxable income context). Specifically, "conservatism" refers to conditional and unconditional conservatism per Basu (1997). The primary objective of my study is to further the use of BTDs in financial statement analysis. I find that, on average, the conditional and unconditional financial statement conservatism of firm-years with large positive BTDs (book income is greater than taxable income) is similar to that of other sample firm-years, while the conditional and unconditional conservatism in taxable income of firm-years with large positive BTDs is greater than that of other sample firm-years. Thus, contrary to teachings in popular accounting textbooks, my main findings suggest that large positive BTDs do not, on average, reveal information about a firm's relative level of financial statement conservatism. I additionally find that, on average, the unconditional financial statement conservatism among firm-years with large negative BTDs (LNBTDs, taxable income is greater than book income) is greater than that of other sample firm-years, and, at the same time, the conditional and unconditional conservatism in taxable income among firm-years with large negative BTDs is less than that of other sample firm-years. Because the increased financial statement conservatism among firm-years with LNBTDs is unconditional in nature, and is not conditional in nature, the increased conservatism among firm-years in this subsample does not translate into higher earnings quality.
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