Tax Rates and Corporate Decision-making. (2nd May 2017)

• Record Type: Journal Article
• Authors: Graham, John R.; Hanlon, Michelle; Shevlin, Terry; Shroff, Nemit
• Is Part Of: Review of financial studies. Volume 30:Number 9(2017:Sep.)
• Page Start: 3128
• Page End: 3175
• Publication Date: 2017-05-02
• Subjects: H25 -- G31 -- M00 -- G02 -- M41; Finance -- United States -- Periodicals; Finance -- Periodicals; 332
• DOI: 10.1093/rfs/hhx037
• Languages: English
• ISSNs: 0893-9454

Abstract

Abstract : We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers' educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities. Received January 12, 2015; editorial decision December 19, 2016 by Editor Robin Greenwood.