The effects of tax convexity on default and investment decisions
Document Type
Journal article
Source Publication
Applied Economics
Publication Date
4-1-2014
Volume
46
Issue
11
First Page
1267
Last Page
1278
Keywords
contingent-claims model, default option, growth option, investment option, tax convexity
Abstract
The objective of this article is to examine how default and investment triggers change under different levels of tax asymmetry when firms face nonlinear tax schedules. Under a convex tax schedule, profits are taxed at a higher rate, while losses are taxed (or rebated) at a lower rate, thus reducing the risk shared by the government. This article presents a dynamic model based on the contingent-claims framework to explore the impacts of tax convexity on the triggers, and we find that the impacts vary significantly depending on several countervailing forces. Tax convexity has a nonmonotonic relationship with both the default and investment triggers, because of the government's risk-sharing role. The default trigger is higher when tax convexity increases, while the growth option exerts a counteracting effect that lowers this trigger, creating an ambiguity in the investment trigger when changing the level of tax asymmetry.
DOI
10.1080/00036846.2013.870653
Print ISSN
00036846
E-ISSN
14664283
Publisher Statement
Copyright © 2013 Taylor & Francis
Access to external full text or publisher's version may require subscription.
Full-text Version
Publisher’s Version
Language
English
Recommended Citation
Lei, A. C. H., Yick, M. H. Y., & Lam, K. S. K. (2014). The effects of tax convexity on default and investment decisions. Applied Economics, 46(11), 1267-1278. doi: 10.1080/00036846.2013.870653