The impact of taxation and financial factors on company investment : an examination using UK panel data
This thesis examines the impact of taxation and financial factors on the level of investment in fixed assets by quoted manufacturing companies in the United Kingdom between 1971 and 1986. Its most important theme is that there exist substantial differences between companies in the way that they are affected by both taxation and financial factors. The empirical work therefore uses individual company accounting and stock market data (described in Appendix A) together with a detailed model of the corporation tax system (described in Appendix B) in order to exploit cross sectional as well as time series variation. Chapters 2 and 3 investigate the role played by taxation in the investment decision. Part of the cross sectional variation in taxation arises through 'tax exhaustion', caused by the asymmetric treatment of taxable profit and loss in UK corporation tax and restrictions on the use of the imputation system. Two investment equations, the first based on Tobin's Q and the second on the cost of capital in an Euler equation framework are developed from the same neoclassical model of the firm which explicitly models tax exhaustion and the role played by expectations. Each is a forward-looking model, which could be used for the purposes of simulating the effects of tax reform on investment, whether the reform is announced or unannounced, permanent or temporary. The results confirm that tax does play a role in the determination of investment, although, for various reasons, the precise effect is difficult to quantify. They also suggest that the Q model is a poor means of assessing the impact of taxation on investment and that it is dominated by the second model. Chapters 2 and 3 also consider the impact of taxation on company financial policy, and, in particular consider various regimes in which the company may find itself which depend on tax exhaustion and agency costs of debt. The stability of these regimes is more complex than commonly argued in the literature. The appropriate definition of the cost of capital is also developed further, under similar conditions, and a matrix of nine possible values is constructed, depending on the marginal source of finance in this period and the next period. Chapter 4 discusses the role played by financial factors. A model with legal constraints on financial behaviour and agency costs on debt is developed which predicts that, for all firms, investment depends on the level of cash generated, as well as Tobin's Q. The importance of cash flow for firms of different size and age is investigated. The results support the hypothesis that cash flow is a significant determinant of investment for all firms. Cash flow has the highest impact for large and new firms.