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The implications of tax loss carryforwards on investment policy

Author

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  • Hervé Roche

    (Universidad Adolfo Ibáñez)

Abstract

This paper explores the effects of tax loss carryforwards (TLCs) on the timing of an irreversible investment. Tax asymmetries restrict the use of TLCs, which induces an option value on the benefits of investing. We highlight the trade-off between the cost of delaying the investment and exercising the option deep in the money in order to expedite the use of the fiscal benefit. The optimal investment trigger turns out to be higher than it will be under a (refundable) tax credit scheme granting the same fiscal benefit at the investment completion date; Bernanke (Q J Econ 98:85–106, 1983) “bad news principle” is now twofold as a drop in earnings delays the use of the fiscal benefit and thus reduces its value. Numerical simulations indicate that the quantitative impact of TLCs is significant. Overall, tax loss carryforwards benefit more large corporations than entrepreneurs.

Suggested Citation

  • Hervé Roche, 2022. "The implications of tax loss carryforwards on investment policy," Mathematics and Financial Economics, Springer, volume 16, number 6, February.
    • Handle: RePEc:spr:mathfi:v:16:y:2022:i:3:d:10.1007_s11579-022-00318-4
    DOI: 10.1007/s11579-022-00318-4
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    More about this item

    Keywords

    Irreversible investment; Tax loss carryforwards; Embedded option;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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