THE EFFECTS OF REGIONAL TAX ENVIRONMENTS ON THE OPTIMAL CORPORATE INVESTMENT STRATEGY
Abstract
This study examines the impact of regional tax variations on the investment decision process of a corporation. Given that a firm is to decide where to locate an investment on the basis of tax differences, the firm must determine the effect of these tax differences on the net aftertax return on its investment. To realistically measure these differences, the tax impacts must be measured over a period of time. This results in an optimal control problem. The solution to the problem yields an optimal investment strategy that will maximize the present value of the investments. The problem is closely related to those papers that study the regional tax impact on corporate investment returns. Previous work deals with only aftertax returns after an investment is made, but not where to make the investment. In developing the problem, literature on regional allocation of national investment, multinational corporations, optimal corporate financial policy, and location theory is examined for relevance. A model from the literature on regional allocation of national investment provides a guide for a model of the problem. Various ideas from the optimal financial policy literature are incorporated into the model to determine how to finance the investment. An analytic solution to the model does not appear to exist due to the problem's complexity. As an alternative, a simulation model is developed that contains an iterative optimization algorithm. This simulation model is loosely based upon a model used to generate the aftertax rate of return on a corporate investment given the region where the investment takes place. The simulation model incorporates several decision variables in the optimization algorithm that allow the firm to decide where to place each year's investment, and how to finance it in order to maximize the present value of the investment. The hypothetical firm included in the simulation has a specific asset structure that can be varied to approximate the asset structure of a real industrial firm. The firm is allowed to decide where to invest among several regions which are based upon real counties, and include the relevant taxes paid by a corporation within a county, such as sales, property, and income taxes. After making several simulation runs with various values for the controlling parameters, it is found that that model is incapable of providing a solution to the problem. This is due to the complexity of the problem, the maximization algorithm employed, and the discontinuities within the various tax functions used. A new model is developed that does not contain any of the financial decisions, and replaces the real world discontinuous tax functions with a continuous tax function. This model provides results illustrating an interaction between a region's tax environment and the return a corporation receives on an investment. This interaction affects where a firm will locate an investment. A firm can be induced to undertake a very costly move in expanding to a new region. The more favorable the region's tax environment is to a particular firm, the greater the inducement.
Degree
Ph.D.
Subject Area
Finance
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