The no-loss offset provision and the attitude towards risk of a risk-neutral firm

This paper examines how discrete tax brackets induce an otherwise risk-neutral firm to behave in a very specific risk-averse manner. We show how the firm's investment decisions relate to various factors, such as other firm revenue,tax rates, tax exemption levels and project risk. In particular, such a firm is shown to exhibit first-order risk aversion, with a possible zero demand for a risky investment, even when the expected excess return is positive. Firm behavior displays risk aversion that is, in some sense, increasing in firm profits at low profit levels, and decreasing at high profit levels. (C) 1997 Elsevier Science S.A.