Progressive taxation and corporate liquidation policies with mean-reverting earnings

Kai Cheung Chu, Kit Pong Wong

Research output: Journal article publicationJournal articleAcademic researchpeer-review

5 Citations (Scopus)

Abstract

This paper develops a real options model of an all-equity financed firm that receives mean-reverting earnings and is subject to progressive taxation. Tax progression arises from an exogenously given tax exemption threshold such that the firm pays no corporate income taxes should its earnings be less than this threshold. The firm possesses a perpetual option to liquidate its operation for a deterministic salvage value at any time. We show that the firm optimally exercises the liquidation option at the first instant when its earnings reach an endogenously determined threshold (the liquidation trigger) from above. Using numerical analysis, we show that the liquidation trigger is higher or lower than the exogenously given tax exemption threshold, depending on whether the tax exemption is below or above a unique critical level, respectively. We further show that the liquidation trigger is strictly decreasing for all tax exemption thresholds less than the critical level, and can be hump-shaped for all tax exemption thresholds greater than the critical level, especially when the salvage value is small. Corporate income taxes as such are not neutral when tax schedules are progressive.
Original languageEnglish
Pages (from-to)730-736
Number of pages7
JournalEconomic Modelling
Volume27
Issue number3
DOIs
Publication statusPublished - 1 May 2010
Externally publishedYes

Keywords

  • Liquidation policies
  • Mean reversion
  • Progressive taxation
  • Real options

ASJC Scopus subject areas

  • Economics and Econometrics

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