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

54 Pages Posted: 4 May 2022 Last revised: 6 Jul 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: April 9, 2022

Abstract

The adoption of the addback statutes significantly reduces business groups’ tax-motivated income shifting via the internal capital market (ICM). Leveraging the quasi-experimental setting created by the addback statutes, we find that the adoption of the addback statutes increases business groups’ ICM and investment efficiency. Using establishment level data from National Establishment Time Series data, we show that the affected establishments experience lower employment growth rate due to less internal financing support. Further evidence show that the addback statutes reduce overinvestment but not underinvestment. The effect of the addback statutes is more pronounced when firms have lower information transparency and are subject to less IRS attention. These evidence support the notion that the addback statues improve the ICM and investment efficiency through reducing firms’ tax-motivated income shifting via internal financing. We rule out the alternative explanation that the addback statues improve ICM efficiency through alleviating the agency problems. We also show that the effect of the addback statutes on ICM and investment efficiency is less pronounced when ICMs are more efficient, measured by lower investment opportunity diversity and higher financial constraints.

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 (April 9, 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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