Differential Taxation and Corporate Futures-Hedging

Abstract

Using a two-moment decision model, this paper analyzes corporate hedging behavior in the presence of differential versus unified income taxation. We start with the well-known result that risk-taking may increase when income tax rates increase and, therefore, the incentive for hedging decreases. We demonstrate that pure hedging is differently affected by taxation from the way speculative hedging is. Analyzing the tax sensitivity of the corporate hedge shows that ahigher risk in the first place may reduce the tax-induced incentive to revise a futures position.