Net operating loss carryforwards and corporate savings policies

We examine the relation between corporate cash holdings and tax net operating loss carryforwards (NOLs). Prior literature demonstrates that firms should distribute cash to shareholders, rather than retain the cash 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 the shareholder's – as in the case of an NOL firm – theory also shows that the firm should retain cash and invest on the shareholder's behalf. Consistent with this, we find that tax losses are associated with higher levels of liquidity; firms save $0.12 to $0.17 per dollar of tax-effected benefit from available NOLs. Furthermore, investors place a higher value on corporate cash in tax loss firms because NOLs shield the returns from tax. The paper adds to the literature studying corporate financial policy responses to taxation and quantifies the role of NOLs in corporate savings decisions