Effects of Corporate Tax Rate Cuts on Firm Investment and Valuation: A Micro Simulation Approach

Abstract

This paper investigates the changes in firm value triggered by corporate tax rate changes for which firms have balances on deferred tax allowances and deferred tax assets. The effects on both investment to fixed/current assets are well taken care of with embedded production functions and firm investment decisions change over time through the accumulated process of retained earnings on the simulated future path. The study is based on micro-simulations, and the data covers the period 2000 to 2008. We note the tax loss carry-forward allowances and net changes in the deferred tax assets affect the equity account and our simulation results demonstrate that the changes in corporate tax rates can enhance market value of equity in most cases, while there are some cases in which the effects are neutral or even detrimental for firm values. With our result both firm financial managers and government regulators must watch very closely the current balance statement status of firm.

Keywords: corporate taxation, tax loss carry-forward, deferred tax assets and liabilities, retained earnings, earnings variability

JEL Classification: M48, G31, H25, D22