Tax Rates and Corporate Decision Making

Review of Financial Studies, Forthcoming

85 Pages Posted: 13 Jan 2015 Last revised: 21 Jan 2017

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

Date Written: January 20, 2017

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.

Keywords: Tax rates, marginal tax rate, effective tax rate, investment, capital structure, behavioral biases, salience, heuristics

Suggested Citation

Graham, John R. and Hanlon, Michelle and Shevlin, Terry J. and Shroff, Nemit, Tax Rates and Corporate Decision Making (January 20, 2017). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2548641 or http://dx.doi.org/10.2139/ssrn.2548641

John Robert Graham

Duke University ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7857 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-668
Cambridge, MA 02142
United States
617-253-9849 (Phone)

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

Nemit Shroff (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main St.
E62-679
Cambridge, MA MA 02142
United States
6173240805 (Phone)

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=51407&co_list=F

Paper statistics

Downloads
1,336
Rank
10,975
Abstract Views
3,594