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Tax Rates and Corporate Decision Making
John R. Graham
Duke University; National Bureau of Economic Research (NBER)
Michelle Hanlon
Massachusetts Institute of Technology (MIT) - Sloan School of Management
Terry J. Shevlin
University of California-Irvine
Nemit Shroff
Massachusetts Institute of Technology (MIT) - Sloan School of Management
January 20, 2017
Review of Financial Studies, Forthcoming
Abstract:
We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers’ educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities.
Number of Pages in PDF File: 85
Keywords: Tax rates, marginal tax rate, effective tax rate, investment, capital structure, behavioral biases, salience, heuristics
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Date posted: January 13, 2015
; Last revised: January 21, 2017
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