Sharing Risk with the Government: How Taxes Affect Corporate Risk Taking

ALEXANDER LJUNGQVIST, LIANDONG ZHANG, LUO ZUO

Journal of Accounting Research · 2017 · Volume 55 · Issue 3

Abstract

Using 113 staggered changes in corporate income tax rates across U.S. states, we provide evidence on how taxes affect corporate risk-taking decisions. Higher taxes reduce expected profits more for risky projects than for safe ones, as the government shares in a firm's upside but not in its downside. Consistent with this prediction, we find that risk taking is sensitive to taxes, albeit asymmetrically: the average firm reduces risk in response to a tax increase (primarily by changing its operating cycle and reducing R&D risk) but does not respond to a tax cut. We trace the asymmetry back to constraints on risk taking imposed by creditors. Finally, tax loss-offset rules moderate firms’ sensitivity to taxes by allowing firms to partly share downside risk with the government.

Keywords

G32, H32, risk taking, corporate taxes

Enable JavaScript for citation tools and additional paper interactions.