Do Tax Incentives Affect Internal Capital Market Efficiency? Evidence from the Addback Statutes

62 Pages Posted: 4 May 2022 Last revised: 6 Nov 2022

See all articles by Tian Tang

Tian Tang

University of Louisville

Liang Xu

SKEMA Business School

Xinyan Yan

University of Dayton

Haoyi Yang

Nanjing University

Date Written: November 4, 2022

Abstract

Addback statutes significantly reduce firms’ tax-motivated income shifting via the internal capital market (ICM). Leveraging a quasi-natural experimental setting, we find that addback statutes increase firms’ ICM and investment efficiency. This effect is robust to a stacked difference-in-differences estimation method. Moreover, addback statutes reduce overinvestment but not underinvestment. The effect of addback statutes is more pronounced when firms have more dispersed state tax rates among subsidiaries, have lower information transparency, and draw less Internal Revenue Service attention. Using establishment-level data from the National Establishment Time Series, we show that establishments in adopting states are less likely to receive internal capital subsidies. The reduction is more pronounced in establishments with higher state tax rates, higher credit ratings, and lower sales growth. Additional tests show that the effects of addback statutes on ICM and investment efficiency are less pronounced when firms have lower investment opportunity diversity and higher financial constraints. In the long run, the adoption of addback statutes has a positive effect on firm performance.

Keywords: Addback Statutes, Internal Capital Market Efficiency, Investment Efficiency, Tax Incentives

Suggested Citation

Tang, Tian and Xu, Liang and Yan, Xinyan and Yang, Haoyi, Do Tax Incentives Affect Internal Capital Market Efficiency? Evidence from the Addback Statutes (November 4, 2022). Available at SSRN: https://ssrn.com/abstract=4079516 or http://dx.doi.org/10.2139/ssrn.4079516

Tian Tang

University of Louisville ( email )

United States
502-852-4819 (Phone)

Liang Xu

SKEMA Business School ( email )

Lille
France

Xinyan Yan

University of Dayton ( email )

300 College Park
Dayton, OH 45469
United States

Haoyi Yang (Contact Author)

Nanjing University ( email )

Nanjing, Jiangsu 210093
China

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