The Impact of Tax Shields on Bankruptcy Risk and Resource Allocation

75 Pages Posted: 21 Oct 2019 Last revised: 6 Jul 2022

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: July 6, 2022

Abstract

This paper studies how tax loss carryforwards affect corporate default rates. Exploiting variation in tax policy across Europe and using a single-country regression discontinuity design, I show that firms are more likely to default when their tax losses provide smaller future cash benefits. This effect occurs predominantly within business groups, which can reallocate internal capital to preserve tax loss shields by delaying the bankruptcy of member firms when tax loss rules are more attractive. Analyses at the aggregate market level further show that the tax-subsidized survival of group firms translates into lower aggregate productivity. The collective evidence sheds new light on the economic consequences of tax loss use and generous tax loss policies. 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 (July 6, 2022). 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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