The Economics of Managerial Taxes and Corporate Risk-Taking
68 Pages Posted: 24 Oct 2017 Last revised: 12 Jan 2019
Date Written: July 10, 2017
Abstract
We examine the relation between managers’ personal income tax rates and their corporate investment decisions. Using plausibly exogenous variation in federal and state tax rates, we find a positive relation between managers’ personal tax rates and their corporate risk-taking. Moreover — and consistent with our theoretical predictions — we find that this relation is stronger among firms with investment opportunities that have a relatively high rate of return per unit of risk, and stronger among CEOs who have a relatively low marginal disutility of risk. Importantly, our results are unique to senior managers’ tax rates — we do not find similar relations for middle-income tax rates. We also find that the tax-induced risk-taking relates to idiosyncratic rather than systematic risk, suggesting that it will not be priced by well-diversified shareholders. Collectively, our findings provide evidence that managers’ personal income taxes influence their corporate risk-taking.
Keywords: Corporate risk-taking; risky investment; risk-taking incentives; personal income taxes; federal income taxes; state income taxes; agency conflict
JEL Classification: G32, H24, J33, M52
Suggested Citation: Suggested Citation