CARRYFORWARDS, INVESTMENT, AND DEBT

Carryforwards have become an ordinary feature of the corporate environ ment. The standard theoretical conclusion is that carryforwards cause an increase in investment Relative to a no loss offset tax, a loss off set includes the government as a partner in bearing the risk of a loss but leaves a gain unaffected. I argue that the standard view ignores the fact that firms can take actions to central their current tax stat us. One way that a firm can change its current tax status is to change its level of debt. I show that if the firm uses risky debt to manage its current tax status, and the depreciation Tax shield is not too lar ge, then investment is negatively related to carryforwards.