Net Operating Loss Carryforwards and Corporate Financial Policies

We examine the relation between net operating loss (NOL) carryforwards and external financing and liquidity decisions using hand-collected data that more precisely measure the value of future tax loss benefits. NOL carryforwards drive variation in corporate tax status and are a key input into measures such as simulated marginal tax rates. Despite this, it is widely recognized that the NOL carryforward value recorded by Compustat suffers from considerable measurement error. We first show that an NOL benefit measure constructed from our data can better predict the reduction in taxes on future profits relative to the commonly used one from Compustat. We then test and find that NOL benefits are positively associated with the marginal use of equity financing, consistent with NOLs increasing the after-tax cost of debt by reducing the present value of interest deductions. NOLs are also associated with larger cash balances and higher cash valuations, as NOLs reduce the tax cost of passive income generated on investments of excess cash. Finally, we offer future research a simple approach to improve estimates of worldwide NOL tax benefits.