What happens when a net operating loss carryforward is exhausted?

Abstract

I study how firm behavior changes after the firm exhausts its NOLC. Prior literature has provided evidence that NOLCs affect firm behavior. Firms that exhaust their NOLC are losing a tax shield and experience a significant change in tax status. Theoretically, firms should change behavior when their NOLC exhausts. However, it appears that not all firm behaviors change when the NOLC is exhausted. I examine firm investment, debt financing, and cash holdings decisions using a six-year window surrounding the NOLC exhaustion to understand the timing and extent of behavior changes. Consistent with my expectations, I provide evidence that investment increases when the firm no longer has an NOLC. However, I fail to find strong evidence that firms change their debt financing or cash holdings decisions in the predicted direction after the NOLC exhaustion. Overall, these findings indicate potential variations in behavior changes. It appears that firms change investment behavior immediately after the NOLC is exhausted, whereas the absence of discernible changes in debt financing and cash holding decisions implies that, if there are changes in behavior in response to the NOLC exhaustion, they are not statistically significant within the observed timeframe. This suggests potential challenges for managers in adapting to full taxation and incorporating muti-year tax benefits.