Mauer, 1988, "Tax-Timing Options
, Leverage, and the Choice of Corporate Form", Journal of Financial Research, 11:99-110
The value of tax-timing options is a third tax-related feature of the parent-subsidiary relationship.
As with standard options, the tax-timing option of any security increases in value with underlying security volatility.
The tax-timing option value, ignoring all transaction costs and market imperfections, is:
Since the term in brackets cannot exceed one when [micro] is positive, the value of the tax-timing option is at most [tau] percent of the company's market value.
Moreover, since shareholders maintain a tax-timing option in parent stock, the value discount can only represent the differences in volatility between parents and carve-out subsidiaries.
Section I describes the model and establishes conditions under which debt maturity structure is irrelevant without investor tax-timing options. Section II examines the effect of debt maturity structure on investor tax-timing option value and establishes that a long-term debt maturity strategy maximizes tax-timing option value.
We first describe the model and establish a set of conditions under which firm value is independent of debt maturity structure without investor tax-timing options. This is important for our subsequent analysis, since we want to isolate the effect of debt maturity structure on investor tax-timing option value.
This paper examines the influence of corporate debt maturity policy on investor tax-timing options. In a model where investors optimally realize capital losses and defer capital gains, we establish that a long-term debt maturity strategy maximizes investor tax-timing option value.
1 A number of studies document evidence on the value of tax-timing options in bond (Jordan and Jordan (1991) and Litzenberger and Rolfo (1983)), stock (Lamoureux and Pooh (1987)), and derivative security prices (Cornell and French (1983)).
Constantinides (1983, 1984) and Constantinides and Ingersoll (1984) show that the ability of investors to realize tax credits on capital losses, and to defer taxes on capital gains, conveys to them a valuable tax-timing option that can contribute significantly to the value of a position in a security.
In this thesis, I extend Lewellen and Mauer's (1988) theoretical model on tax-timing option
by incorporating derivatives and show how firms use derivatives to exploit tax-timing and tax-character options in order to enhance firm market value.