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In sum, we empirically and successfully demonstrate that estimated stochastic
processes of net income after taking into consideration the balance of both DTA and
LCA can reveal the net effect of a corporate tax rate cut on firm values. The result is a
new contribution to the literature, in particular, for countries with uniform tax
reporting systems.
6
Conclusion
This paper addressed a fundamental query to assess changes in firm values triggered
by hypothetical corporate tax rate changes. The study is based on a microsimulation
of all listed firms in Japan. We utilized the fundamental residual income valuation
model by Ohlson (1995). In disentangling the effects on firm value by corporate tax
rate changes, we paid particular attention to the net changes on deferred tax liabilities
in the equity account and the contra account of deferred tax assets. Future paths of
taxable net income for all individual firms were then computed with industry-wise
multiplicative production functions and firm specific accounting variables. By
discounting the future income of firms with the equity cost of capital computed with
the three-factor asset pricing model (Fama and French, 1993) for each simulation
path, we obtain new hypothetical values for all firms after all corporate tax effects
were fully taken care of in future periods.
We find firm values may increase, do not change, or decrease even if the corporate
tax rate is cut. Hence, for regulators, the timing decision of a tax rate cut is a sensitive
decision based on past deferred tax states of firms, past profitability and variability,
and business cycles. Similarly, for corporate financial managers, it is important to
counteract tax rate cuts in changing investment decisions, again based on deferred tax
states, past firm profitability and variability, and business cycles of each industry.
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