Net Operating Loss Carryforwards and Corporate Savings Policies

ABSTRACT We examine the relation between corporate cash holdings and tax net operating loss carryforwards (NOLs). The literature demonstrates that firms should distribute cash to shareholders rather than retain it and generate passive investment income taxed at both corporate and investor levels. However, if the firm's tax rate on passive income is lower than shareholders'—as when the firm has NOLs—theory also shows that the firm should retain cash and invest on the shareholders' behalf. Consistent with this, we find that NOLs are associated with higher levels of savings; firms save an additional $0.12 to $0.17 per dollar of tax-effected NOL benefit. Furthermore, investors place a higher value on corporate cash in tax loss firms, consistent with NOLs increasing the after-tax returns on passive investments. The paper adds to the literature studying corporate financial policy responses to taxation and quantifies the role of NOLs in corporate savings decisions.