An innovative analysis of taxes and corporate hedging

Theoretical research predicted that firms with convex tax schedules would hedge to minimize expected taxes. However, previous empirical research did not detect a relationship between derivative use and tax losses carry forward, which contribute to tax schedule convexity. This study aims to show that the tax incentive to hedge depends on tax losses carry forward and the ability of the firm to carry losses forward and back, which depends on the distribution of taxable income. A new measure of the tax incentive to hedge, which incorporates this, will be proposed. Hedging could be accomplished by methods other than by using derivatives. Measures of hedging activity which incorporates the effect of all methods of hedging, and which are consistent with previous theoretical research, will also be proposed. Using the new measures of the tax incentive to hedge and hedging activity, the firm’s tax incentive to hedge will be empirically established to significantly influence its hedging activity. © 2000 Elsevier Science B.V. All rights reserved.