Loss or Lost? Tax Shields and Internal Capital Market Outcomes in Business Groups

This paper studies how tax shields of loss-making entities affect resource allocation within business groups. Evidence from a large international sample and a single-country regression discontinuity design suggests that groups avoid their member firms' defaults when tax shields from loss-carryforwards are greater. This tax-motivated group support keeps low-quality firms alive, hampers productivity at the consolidated group level, and has negative spillover effects within industries. These findings indicate that lenient loss-offset tax rules encourage group support and thereby mitigate bankruptcy risk. However, this tax policy is also costly as business groups tend to divert resources away from their most productive use. Collectively, this study provides novel insights into the relationship between taxes and internal resource allocation, an important driver of economic growth