Net Operating Loss Carryforwards and Corporate Savings Policies
56 Pages Posted: 12 Jun 2018 Last revised: 15 Feb 2019
Date Written: February 14, 2019
We examine the relation between tax net operating loss (NOL) carryforwards and corporate savings. Prior research finds that firms accumulate cash for precautionary reasons. While savings provide firms with necessary liquidity reserves, firms may incur taxes on returns earned on accumulated cash; thus, it is generally more tax-efficient for firms to distribute excess cash to shareholders than to generate passive investment income subject to double taxation. However, NOL carryforwards shield passive income from corporate tax, thereby lowering the cost of holding cash in the corporation and increasing optimal cash levels. We test whether and to what extent NOL tax benefits are associated with cash holdings. To do so, we develop a new proxy for worldwide NOL benefits that more accurately captures their value and variation across jurisdictions. Consistent with our predictions, we find that NOLs are positively associated with cash holdings, and this effect is incremental to other tax-related motivations for holding liquid assets. We also find that investor valuation of cash is increasing in the firm’s NOLs, suggesting that investors place a higher value on a firm’s liquidity when the corporate tax cost is low. The paper extends the literature on NOLs by demonstrating their role in corporate savings policies. Further, we demonstrate the importance of proper NOL measurement.
Keywords: Net Operating Losses, Taxes, Debt, Equity, Cash
JEL Classification: H25, H26, K34, G32, G38, M41
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