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as a uniform reporting system in the sense that depreciation methods, inventory
costing, or other major accounting choices have to follow uniform reporting both for
tax and financial accounting purposes.
2.2
Objectives of the Study
In this paper we try to assess the importance of the provisions mentioned above, when
the corporate tax rate is changed, which could affect firm valuation. The effects of tax
rate changes on firm valuation becomes complex with state-dependent integral
equations for a multi-period case, and so we use a simulation method. Note the tax
loss carry-forward allowances are valid only up to a maximum of seven years during
our sampling period by the Corporation Tax Act in Japan. The topic entry of deferred
tax assets is also expected to be reversed within five years in order to be certified by
CPAs. However, note that future income streams of firms possess infinite lives as
going concerns. Every year, new entry of tax allowances when a firm incurs losses
and deferred tax assets or liabilities are recorded will generate accumulated processes
with finite lives.
We emphasize that our analysis is quite important from the viewpoint of both
regulators and corporate managers. Regulators would want to assess the directions of
new investment behavior by firms triggered by the statutory tax rate cut for the
purpose of implementing better economic policies, and at the same time investment
decisions chosen by corporate managers may change through their rational responses
to corporate tax rate changes (MacKie-Mason, 1990). Hence, such changes in firm
behavior will significantly change the allocation of scare resources both in industries
and in an economy.
With these considerations we try to empirically identify the type of firms which
undergo favorable changes, neutral effects, or unfavorable changes, triggered by the
enactment of corporate and individual financial income tax rate cuts.
3
Corporate Investment and Valuation
3.1
Evolution of Firms' Retained Earnings and Investment
We construct a corporate investment model with time evolvement equations of the
accounting variables as follows.
dca
g
dca
g
dca
/
TA
=
c
⋅
(
/
TA
)
+
c
⋅
RE
/
TA
+
ε
j
,
t
j
,
t
−
1
0
,
j
,
t
−
1
1
j
,
t
−
1
j
,
t
−
1
j
,
t
MA
g
MA
g
InvMA
/
TA
=
c
⋅
(
/
TA
)
+
c
⋅
RE
/
TA
+
ε
j
,
t
j
,
t
−
1
0
,
j
,
t
−
1
1
j
,
t
−
1
j
,
t
−
1
j
,
t
InvBU
/
TA
=
c
BU
g
⋅
(
/
TA
)
+
c
BU
g
⋅
RE
/
TA
+
ε
(1)
j
,
t
j
,
t
−
1
0
,
j
,
t
−
1
1
j
,
t
−
1
j
,
t
−
1
j
,
t
GW
g
GW
g
InvGW
/
TA
=
c
⋅
(
/
TA
)
+
c
⋅
RE
/
TA
+
ε
j
,
t
j
,
t
−
1
0
,
j
,
t
−
1
1
j
,
t
−
1
j
,
t
−
1
j
,
t
P
P
InvP
/
TA
=
c
⋅
(
/
TA
)
+
c
⋅
RE
/
TA
+
ε
j
,
t
j
,
t
−
1
0
,
g
j
,
t
−
1
1
g
j
,
t
−
1
j
,
t
−
1
j
,
t
