This study examines the form of the association between tax reserves and firm value. I find firm value is increasing in tax reserves at a diminishing rate until an optimal level is reached, after which firm value is decreasing in tax reserves. This concave association is consistent with investors having a firm-specific, optimal level of tax reserves where the expected benefits equalthe expected costs. Conditional conservatism moderates this association such that investors of conservative firms are less sensitive to changes in tax reserves. I also decompose firm value into the numerator (expectations of future cash flows) and the denominator (cost of capital) and find the numerator impact is the primary driver of the concave association between tax reserves andfirm value. The results highlight the importance of understanding how investor valuation of tax reserves may vary depending on the current level of tax reserves.
Research Article| July 01 2020
The Concave Association Between Tax Reserves and Equity Value
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Rebekah D. Moore; The Concave Association Between Tax Reserves and Equity Value. Journal of the American Taxation Association doi: https://doi.org/10.2308/JATA-17-109
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