Net Operating Loss Carryforwards and Corporate Savings Policies

56 Pages Posted: 12 Jun 2018 Last revised: 15 Feb 2019

See all articles by Shane Heitzman

Shane Heitzman

University of Southern California - Marshall School of Business

Rebecca Lester

Stanford Graduate School of Business

Date Written: February 14, 2019

Abstract

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

Suggested Citation

Heitzman, Shane and Lester, Rebecca, Net Operating Loss Carryforwards and Corporate Savings Policies (February 14, 2019). Stanford University Graduate School of Business Research Paper No. 18-29. Available at SSRN: https://ssrn.com/abstract=3185018 or http://dx.doi.org/10.2139/ssrn.3185018

Shane Heitzman (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Rebecca Lester

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://www.gsb.stanford.edu/faculty-research/faculty/rebecca-lester

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