Tax Loss Carryovers in a Competitive Environment

Abstract

We examine operating and investment decisions in a duopolistic industry in which an initial investment in research yields an immediate tax benefit for one firm, but creates a net operating loss carryover for the other firm. We show that the conventional wisdom that suggests that the first firm is in a better position to make the research investment need not hold in a competitive environment. This occurs because if both firms invest in research, the firm with the net operating loss carryover makes more aggressive investment decisions following successful research.