The Impact of Tax Shields on Bankruptcy Risk and Resource Allocation

63 Pages Posted: 21 Oct 2019 Last revised: 5 Apr 2021

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: April 02, 2021

Abstract

This paper studies how tax shields from loss carryforwards affect corporate default rates and productivity. Exploiting variation in tax policy across European countries and a single-country regression discontinuity design, I show that firms are less likely to default when they have greater tax losses that provide future cash benefits. This effect occurs predominantly within business groups, which are more able to exploit tax incentives through their internal capital markets and thereby attenuate the bankruptcy risk of member firms. While generous tax loss policy aids firms in responding to economic crises, results also show that these tax shields subsidize unproductive group member firms, translating into lower aggregate productivity at the industry level. Collectively, this study sheds new light on the economic consequences of tax loss use, thereby informing policy changes that permit more generous loss utilization in light of the recent economic crisis.

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 (April 02, 2021). 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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