AN INVESTIGATION INTO THE EFFECTS OF FREQUENT TAX POLICY CHANGES ON FIRM RISK

Scope and method of study. The purpose of this study was to investigate the effects of a history of tax changes on firm risk. A sample of 68 firms was selected for investigation. All of these firms met the requirement that they be included on both the Compustat and CRSP data bases for each year from 1975 through 1988, inclusive. The effects of each of the major tax changes in the 1975-1988 period as the cash flows of the sample companies were estimated. These estimates were used to compute measures of the frequency of the tax changes and the variability of the effects of the tax changes on the cash flows of each firm. Also computed were measures of the effect of the tax changes on the overall cash flow variability of each firm. Measures of the total, systematic and unsystematic risk for each firm were computed. Three models were formed in which the dependent variable in each model was a different measure of risk (total, systematic, or unsystematic). The independent variables in all three models were nine variables that had, in previous studies, been found to be related to risk. A regression analysis was performed on each of the three models. Independent variables were dropped from models in which they were not related to the dependent variable. The tax change frequency and variability measures, as well as the measure of the effect of tax changes on the overall cash flow variability, were added to the resulting models as independent variables. Regression analyses were performed for each model. The existence of relationships between the independent variables and the dependent variables were investigated by considering the p-values of the coefficients of the variables of interest.; Findings and conclusions. This study found evidence ({dollar}p{dollar} {dollar}<{dollar}.011) of relationships between the effect of tax changes on the growth-adjusted variability of cash flows and both total and unsystematic risk. No evidence was found indicating that the frequency and variability of tax changes are related (either separately or jointly) to either total or unsystematic risk. The evidence did not indicate that tax changes are related to systematic risk.