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The effects of tax convexity on default and investment decisions
Applied Economics
  • C. H., Adrian LEI, University of Macau
  • Ho Yin, Martin YICK, Lingnan University, Hong Kong
  • S. K., Keith LAM, University of Macau
Document Type
Journal article
Publication Date
  • contingent-claims model,
  • default option,
  • growth option,
  • investment option,
  • tax convexity

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.

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Copyright © 2013 Taylor & Francis

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Citation Information
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