The Impact of Tax Shields on Bankruptcy Risk and Resource Allocation

50 Pages Posted: 21 Oct 2019 Last revised: 2 Jan 2023

See all articles by Marcel Olbert

Marcel Olbert

London Business School - Department of Accounting; ZEW – Leibniz Centre for European Economic Research - Corporate Taxation and Public Finance Research

Date Written: January 1, 2023

Abstract

This paper studies how tax loss carryforwards affect corporate bankruptcies. Exploiting variation in tax policies across Europe and using a single-country regression discontinuity design, I show that firms are more likely to go bankrupt when stricter loss carryforward rules decrease expected future cash flows. This effect occurs predominantly within business groups, suggesting that managers reduce the support of struggling member firms through internal capital markets when stricter tax rules reduce these firms' tax loss shields. Industry-level analyses further show that the tax-subsidized survival of group firms under lenient LCF rules translates into lower aggregate productivity. The collective evidence suggests that generous tax policies can prolong firm survival but also create tax planning incentives that can impair the allocation of resources to the most productive firms. The results are particularly timely in light of the recent economic crises, in which many countries altered their tax loss rules.

Keywords: Business groups, Internal capital markets, Resource allocation, Financial distress, Losses, Corporate taxation, Productivity

JEL Classification: G32, G33, H25, M41, M48, D22, D24

Suggested Citation

Olbert, Marcel, The Impact of Tax Shields on Bankruptcy Risk and Resource Allocation (January 1, 2023). Available at SSRN: https://ssrn.com/abstract=3467669 or http://dx.doi.org/10.2139/ssrn.3467669

Marcel Olbert (Contact Author)

London Business School - Department of Accounting ( email )

Sussex Place
Regent's Park
London, NW1 4SA
United Kingdom

ZEW – Leibniz Centre for European Economic Research - Corporate Taxation and Public Finance Research ( email )

United States

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