The Effect of Acquirer Net Operating Losses on Acquisition Premiums and Acquirer Abnormal Returns

Merle Erickson *

Karen Ton **

Shiing-wu Wang ***

Abstract:

This study examines the effect of acquirer pre-acquisition net operating losses (NOLs) on i) acquisition premiums, and ii) acquirer abnormal announcement returns. For a sample of 1,986 acquisitions, we find that acquisitions of profitable targets by acquirers with NOLs are associated with higher acquisition premiums than acquisitions by non-NOL acquirers. We also find that acquirer abnormal announcement returns are positively associated with estimated tax benefits from accelerated utilization of acquirer NOLs. Finally, we provide some anecdotal evidence that indicates in some transactions, accelerated use of the acquirer’s NOLs influences the price paid and the expected acquirer’s tax benefits.

Preliminary and Incomplete Draft

* Booth School of Business, University of Chicago** Goizueta Business School, Emory University*** Leventhal School of Accounting, University of Southern California

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1. Introduction

Tax costs and benefits are a part of mergers and acquisitions, and managing these tax factors is

often an important consideration in the transaction. While considering the tax costs of a merger is

important, preservation of tax attributes of the combined entity can also be a significant issue. For

example, pre-acquisition net operating losses (NOLs) for both parties may disappear or be limited after

the transaction thereby increasing the combined firms’ post-acquisition tax costs. On the other hand,

preservation and use of these tax attributes can decrease tax costs and increase post-merger after-tax cash

flows of the combined entity.

In an acquisition of a publicly traded free-standing corporation (target), the purchase price

premium, the price paid above the target’s pre-acquisition market price, generally reflects the value of the

target to the acquirer in the transaction (Asquith, Bruner, and Mullins 1983). The higher the potential

value that the target adds to the combined entity, the greater the premium the suitor is willing to offer.

Many factors add to the value of the combined entity, e.g., synergies, etc. (Bradley, Desai, and Kim 1983;

Eckbo 1983; Shleifer and Vishny 2003; Moeller, Schlingemann, and Stulz 2004). Similarly, the acquirer’s

abnormal returns in response to announcement of the acquisition reflect expectations about the effect of

the transaction on the acquirer’s value.

This study examines the effect of the acquiring firm’s net operating loss carryforward (NOL)

status on acquisition premiums and acquirer abnormal returns. An acquirer may efficiently utilize such

NOLs by acquiring a profitable target and using its pre-acquisition NOLs to shield the target’s post-

acquisition profits from taxation. The benefits come in the form of reduced post-acquisition tax payments

and therefore higher after-tax cash flows as the acquirer’s NOLs are used to shield the target’s post-

acquisition profits from taxation. As a result of the potential increased cash flows resulting from more

effective and timely use of the acquirer’s NOLs, acquiring firms may be willing to share some of the

value created with target shareholders in the form of higher acquisition premium.1

1 Similarly, the target could have net operating loss carryovers that can be a valuable asset to profitable acquirers. As such, tax benefits of target’s NOL may be reflected in a higher acquisition premium for NOL targets as shown in Hayn (1989) for pre-1986 acquisitions. The ability of the acquirer to utilize the target’s NOLs was limited by changes included in the Tax Reform Act of 1986, namely I.R.C. Section 382.

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Unprofitable operations result in NOLs that can be carried forward to offset taxable income in

future periods. NOLs, if not used in the current period, decline in value with time and lose all value if

they expire unused. Similarly, the value of an NOL declines if the NOLs are limited by specific

provisions of the tax law.2 As such, for a firm with NOLs, an acquisition may enable the firm to utilize its

NOLs in a more timely manner.3 The tax benefits from both the increase in the amount of acquirer NOL

used and the timeliness with which the NOL is used can be a source of value creation in an acquisition.

Such value creation is greatest in the combination of an acquirer with NOLs and a profitable target. In a

competitive market, acquirers with NOLs may be willing to pay more for profitable targets than acquirers

without NOLs. Given the potential value created in combinations of acquirers with NOLs and profitable

targets, we analyze whether these tax benefits are associated with increased acquisition premiums. We

also investigate whether acquirers with NOLs realize more positive abnormal returns around the merger

announcement than acquirers without NOLs.

We identify a sample of acquisitions of profitable targets by acquirers with NOLs (“NOL

acquirers”) as well as a sample of acquisitions by acquirers without NOLs (“non-NOL acquirers”). When

comparing acquisitions completed by NOL acquirers to those completed by non-NOL acquirers, we find

evidence that acquisition premiums are higher for NOL acquirers, after controlling for factors such as the

target’s profitability, deal characteristics, and method of payment in the deal (cash vs. stock). We also

find that estimates of tax benefits from accelerated use of acquirer NOLs are positively associated with

acquisition premiums.

We also analyze the effect of acquirer NOL status on acquirer abnormal returns in response to the

merger announcement. When the acquirer has NOLs and it acquires a profitable target, the target’s future

profits may allow the acquirer to use its NOLs more efficiently thereby increasing the present value of

future after-tax cash flows from the target. If the acquirer does not fully incorporate that expected tax

2 NOLs have a 20-year useful life under current U.S. law. Certain changes in the ownership of the equity of a firm with NOLs can result in limitation on the use of NOLs after the limitation triggering event. Such limitations are defined under I.R.C. Section 382.

3 An acquiring firm’s NOLs can be used to reduce the income taxes due on the target’s post-acquisition profits, but the acquirer’s NOLs cannot be carried back to obtain a refund of pre-acquisition taxes paid by the target.

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benefit in the purchase price paid, then the acquirer may retain some or all of these future tax benefits and

those benefits may be reflected in the acquirer’s merger announcement stock returns. Consistent with that

notion, we find that NOL acquirers realize more positive (less negative) abnormal returns in response to

the merger announcement. Furthermore, we find that our measure of the estimated tax benefits from

monetizing the acquirer’s NOLs with the target’s profits is positively associated with the acquirer’s

merger announcement abnormal returns.

The use of NOLs is subject to several limitations that can reduce or even eliminate the potential

tax benefit of acquiring a profitable target. For example, large issuances of the acquiring firm’s stock in a

transaction may create a significant change in the firm’s equity structure and trigger I.R.C. Section 382.

In additional analyses, we examine a subset of firms with transactions that are likely to trigger a Section

382 limitation. Compared to transactions that are unlikely to trigger the Section 382 limitation, we find

that acquisition premiums are lower and the acquirer’s abnormal returns are lower for transactions in

which acquiring firms are more likely subject to a Section 382 limitation.

In our study, we conduct our primary tests with acquisitions of profitable targets because the

combination of acquirers with NOLs and a profitable target potentially leads to the tax based value

creation that is the focus of this study. In supplemental analyses, we examine acquisitions of unprofitable

targets to explore the possibility that acquirers with NOLs are generally associated with higher acquisition

premiums and acquirer returns. We find no significant difference in acquisition premiums of unprofitable

targets between NOL acquirers and non-NOL acquirers. We also find that NOL acquirers have lower

(more negative) announcement period abnormal returns in response to the merger announcement of

unprofitable targets relative to profitable targets.

Finally, we provide several pieces of anecdotal evidence that support the conclusion that tax

benefits from use of acquirer NOLs to shield the target’s profit from taxation are a motivating factor in

some mergers. We also find evidence that these tax benefits affect acquisition premiums and are expected

to provide value to the acquirer.

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The remainder of this study is organized as follows. Section 2 provides background on NOLs and

the tax rules relating to NOLs as well as the treatment of NOLs in post-acquisition periods. Section 3

describes the sample selection process and provides descriptive statistics for the sample. Section 4

presents the analyses and results. Section 5 summarizes and concludes.

2. Overview

Many factors are considered in the structuring and pricing of mergers and acquisitions. Taxes are

one such factor since tax effects can lead to not only significant but also sometimes immediate cash flow

consequence for both parties. Acquisition related tax effects have received significant attention in prior

research (e.g., Kaplan 1989; Erickson 1998; Maydew, Schipper, and Vincent 1999; Erickson and Wang

2000; Ayers, Lefanowicz, and Robinson 2004; Erickson and Wang 2007). Tax effects considered in prior

research include: i) whether the transaction is taxable or tax-free to the target’s shareholders, ii) does the

transaction change the tax bases of the target’s assets and, iii) whether or not the target’s tax attributes,

such as NOLs, can be preserved and used post-acquisition. Because these tax consequences are part of the

transaction’s cost or benefit, taxes can be reflected in the acquisition’s price. Many prior studies have

examined the effects of the first two of these tax effects on acquisitions, and there is some prior analysis

of the effect of target NOLs on acquisitions. However, there is little prior research that has evaluated the

role of acquirer NOLs in acquisition premiums and acquirer shareholder wealth effects, which are the

focus of this study.4

The most common and significant type of tax attribute for U.S. based firms is tax losses. These

tax losses can be carried back or carried forward to offset profits generated in the past or the future,

respectively.5 Tax losses that can be carried forward are referred to as tax loss carryforwards or NOLs.

4 Prior research considers the effect of the tax status of the transaction (e.g., tax benefits (Auerbach and Reishus 1988), shareholder taxes (Ayers, Lefanowicz, and Robinson 2003), goodwill tax deductions (Ayers, Lefanowicz, and Robinson 2000; Henning and Shaw 2000)) on deal structure and acquisition premium, and the step-up in the tax basis of the target’s assets (Erickson 1998; Erickson and Wang 2000; Erickson and Wang 2007). Some studies consider the role of target NOLs on deal structure and acquisition premium (Hayn 1989; Givoly et al. 1992; Erickson 1998).

5 Maydew (1997) and Erickson, Heitzman and Zhang (2013) analyze actions firms take to increase the value of tax loss carrybacks.

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Utilization of NOLs reduces or eliminates tax payments on future profits.6 As a result, NOLs are valuable

assets.

A merger or acquisition can accelerate the use of a firm’s NOLs in the case of either a profitable

corporation acquiring a loss corporation or a loss corporation acquiring a profitable corporation. The

potential abuses of purchasing target firms with NOLs to obtain tax benefits gave rise to restrictions

limiting the use of NOLs in certain types of transactions. One of the most far-reaching rules affecting the

use of NOLs is Internal Revenue Code Section 382. It mandates that if there is a significant change in the

equity ownership of a corporation with NOLs, the use of its NOLs will be limited in the future. The

reduction in NOL use is in place to prevent a profitable firm from acquiring a loss firm simply so that the

profitable firm can use the target’s NOLs (so-called trafficking in losses).7 Because most takeovers of

loss firms result in an ownership change of the loss firm as specified in Section 382, that tax provision

effectively discourages takeovers of loss firms solely for tax purposes.8 On the other hand, when an

acquiring firm has NOLs, the ability to use its NOLs to shield the target’s profits from taxes is much less

restrictive.9

In general, the tax structure of the acquisition does not prohibit or limit the use of the acquirer’s

NOLs post-closing unless the acquirer issues a large amount of its stock as the form of payment for the

target. The latter could give rise to a significant change in the equity ownership of the acquiring

corporation as defined in I.R.C. Section 382 and the acquiring corporation’s NOLs may be limited as a

result. Specifically, under Section 382, the limitation is triggered if there is a 50% change in ownership of

the acquirer’s stock. The limitation is an annual amount determined at the closing of the acquisition equal 6 Under current law, NOLs can be carried back two years or carried forward twenty years to offset profits giving rise to

low or no tax on these profits. The carryback and carryforward period of NOL varies historically. For example, prior to the current rule (enacted August 6, 1997), NOL carryback and carryforward periods were 3 and 15 years, respectively.

7 The 1986 Tax Reform Act that severely limits the use of NOLs substantially revised the current Section 382.

8 In the acquisition of a freestanding C corporation, the tax structure selected almost always results in the preservation of the target corporation’s NOLs, although the target’s NOLs will almost always be limited post-acquisition. See Chapters 14 and 16 of “Taxes and Business Strategy,” 5th edition, Scholes, Wolfson, Erickson, Hanlon, Maydew and Shevlin (2014) for discussion of the tax structures used to acquire freestanding C corporations and the effect of those structures on various tax factors.

9 The limitation in such a circumstance, if applicable at all, also appears under I.R.C. Section 382. As a general rule, the 382 limitation on the acquirer’s NOLs is triggered when the acquirer issues a large amount of its stock (relative to the pre-acquisition amount of stock outstanding) in the acquisition.

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to the acquirer’s equity at the time of the ownership change multiplied by the federal long term tax

exempt rate.10

In sum, when the acquiring corporation has NOLs, those NOLs are often available to offset post-

merger profits of the combined entity. As a result, the tax rate on a profitable target corporation’s post-

merger profits will be lower than it otherwise would have been, and may be zero for several periods.

There is no similar tax benefit if the acquiring corporation is profitable and does not have NOLs. This

suggests that holding other factors constant, a profitable target firm is more valuable to an acquiring

corporation with NOLs than an acquiring firm without NOLs. Because the profitable target is more

valuable to the NOL acquirer, an acquiring corporation with NOLs may be willing to pay a higher price

than a profitable acquiring corporation would.

3. Sample Selection and Composition

Our sample consist of all acquisitions of profitable freestanding U.S. corporations by U.S.

acquiring corporations from 1987 to 2015 from the Securities Data Corporation (SDC) Platinum database.

The initial sample selection from SDC resulted in 12,269 observations. We then excluded stock

buybacks, exchange offers, and recapitalizations from this sample. Because we need financial statement

and stock price data for our analyses, we also excluded observations that could not be matched with

Compustat and CRSP data. This left us with 3,762 observations. We also exclude acquisitions with

unprofitable targets, targets with NOLs, and targets with missing financial statement data.11 We examine

the tax footnote of NOL acquirer firms to identify the domestic portion of NOLs. We eliminate NOL

acquirers with only foreign NOLs.12 This resulted in an initial sample of 1,986 observations of 10 The federal long term tax exempt rate is a rate published by the Treasury monthly. To illustrate the mechanics of the

Section 382 limitation, assume an acquirer with $500 million of NOLs. Assume at the time of an acquisition of a target in which the acquirer purchases the target with its stock, the acquirer’s equity value is $2 billion and the federal long term tax exempt rate is 4%. Post-closing, and assuming that the acquisition triggers Section 382, the acquirer could use $80 million of its NOLs each year to reduce the taxable income of the combined entity ($2 billion market value of equity multiplied by the 4% long term tax exempt rate).

11 We include profitable targets where the target’s NOL variable is zero and target domestic taxable income is greater than zero.

12 Foreign NOLs can not be used directly to offset domestic profits. As such, the target’s profits do provide direct tax benefits an acquirer with foreign NOLs. In order to avoid confounding effects, we exclude acquirers with only foreign NOLs from our sample.

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acquisitions of profitable corporations. See Table 1 for details of our sample selection process and sample

composition.

We partitioned the sample into two subsamples by whether or not the acquiring corporation had

NOL carryovers at the time of the acquisition. The partition resulted in 301 NOL acquiring corporations

and 1,685 non-NOL acquiring corporations. Table 2 contains descriptive statistics for the entire sample

and the two subsamples of acquirers with and without NOLs.

For the entire sample, the average acquirer market value of equity prior to acquisition is $9.5

billion (median of $1.6 billion) and the average (median) target market value of equity was $973.5

million ($158.1 million) for target corporations. The average (median) purchase price paid is about $1.4

billion ($259.7 million). The mean deal ratio is 0.43 indicating that the target corporation was purchased

at a price equivalent to about 43% of the acquiring corporation pre-acquisition market value of equity.

About 15.2% of the acquiring corporations have NOLs, and the average (median) NOL for those

acquirers with NOLs is about $296.6 million ($67 million).

4. Analyses and Results

4.1 Target Acquisition Premiums

We define acquisition premium as the two-day market-adjusted abnormal returns of the target

based on the announcement date of the acquisition, and the date immediately preceding the announcement

of the acquisition to be consistent with prior studies, (Asquith 1983; Asquith, Bruner, and Mullins 1983;

Jensen and Ruback 1983; Huang and Walkling 1987). The market model below was estimated for each

target firm in our sample (Schwert 1996; Bargeron et al. 2008)

Rit = αi + βiRmt + ϵit, (1)

where Rit is the stock return to firm i on day t, Rmt is the market return on day t, and αi, and βi are firm i's

market model parameter estimates calculated during the estimation period. The estimation period is t =

day -250 to -20 where day 0 is the date that the acquisition is announced. Based on estimates of α and β

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from above, we then compute event period abnormal returns (CAR) as the sum of the two day abnormal

returns (ARit)

ARit = Rit – (αi + βiRmt) (2)

for each day t during the event period.

Table 3 presents target cumulative abnormal returns (for days 0 and -1). The cumulative

abnormal returns are reported separately for a target’s one and two-day abnormal returns around the

acquisition announcement date for the entire sample and for the NOL acquiring corporations and the non-

NOL acquiring corporations respectively.

For the overall sample, the average (median) two-day abnormal returns for the target corporations

are 16% (10.6%). Both the mean and median abnormal returns are positive and statistically different from

zero (p<.01). These results are consistent with prior research that shareholders of the target corporation in

general realized significant abnormal returns on the announcement of the acquisition (Huang and

Walkling 1987). When the sample is partitioned based on whether the acquiring corporations does or does

not have NOLs, we find that target abnormal returns are higher for acquirers with NOLs. When the

acquirer has NOLs, the average two-day abnormal returns are 18.9% while the average two-day abnormal

return is 15.4% when the acquirer does not have NOLs. That 3.5% difference is statistically significant

(p<.01). Similar results are observed for median returns. The higher target abnormal returns observed

when the acquirer has NOLs is consistent with the conclusion that NOL acquiring corporations pay higher

acquisition premiums than non-NOL acquiring corporations.

As prior research has documented there are other factors affecting acquisition premiums, and as a

result, we incorporate such factors in our analysis to control for these non-tax factors as specified below.

tCAR2it = β0 + β1aNOL + β2 tROE + β3 tMTB + β4 tLEVERAGE + β5 tREVENUE + β6 STOCK + β7

HOSTILE + β8 MULTIBID + β9 POOLING + β10 SAMEIND + β11 DEALRATIO + εit , (3)

where tCAR2 is the target corporation’s two-day (days -1 and 0) abnormal return and aNOL is an

indicator variable equal to 1 when the acquiring corporation has domestic NOLs, zero otherwise. Target’s

return on equity, denoted tROE, market-to-book ratio, denoted tMTB, and leverage, denoted tLEVERAGE

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are included to control for the effect of target profitability, leverage and market to book ratio on the

abnormal returns. As a target’s growth also expected to affect the price in the acquisition, the equation

includes tREVENUE equal to the target's average revenue growth over the previous two year period prior

to the acquisition. We make no prediction about the sign of the coefficient on tROE, tMTB, tLEVERAGE

and tREVENUE.

STOCK is an indicator variable equal to one when the percentage of the total consideration paid

for the target is fifty percent or more acquiring corporation stock, and zero otherwise. In general, the

acquisition transaction will be tax-free if total consideration paid is at least 40% acquiring firm stock. As

a result, the indicator for stock should pick up the effect tax status of the transaction. In a taxable

transaction, the target corporation and its shareholders will incur an immediate tax liability. To

compensate for the higher tax costs of a taxable transaction, it is possible that the seller will demand a

higher premium (Carleton et al. 1983; Huang and Walkling 1987). Furthermore, as discussed above, use

of acquiring firm stock may result in a limitation on the utilization of the acquirer’s NOLs, reducing the

value of those NOLs to shield future target profits from taxation. As a result of both effects, we expect the

coefficient on STOCK to be negative.

We also include controls for various deal characteristics that may affect the acquisition premium.

HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise.

We control for hostile deals because aggressive bargaining by target managers may increase acquisition

premiums and reduce acquirer stock returns (Schwert 2000). MULTIBID is an indicator variable equal to

one if there are multiple bidders for the target and zero otherwise. Multiple bids are included because

multiple-bidder contests can increase acquisition premiums and decrease acquirer returns (Bradley, Desai,

and Kim 1988). POOLING is an indicator variable equal to one if the acquiring firm used the pooling of

interests accounting method and zero otherwise. We control for accounting method because prior research

finds that firms pay higher acquisition premiums to use the pooling-of-interest accounting method (Ayers,

Lefanowicz, and Robinson 2002), which was prohibited by SFAS No. 141 after June 30, 2001.

SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit

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SIC and zero otherwise. We include this variable to control for the effects of a diversification discount or

premium (Servaes 1996; Villalonga 2004). DEALRATIO is the deal value scaled by the acquiring firm’s

market value of equity. We consider the relative size of the target because it can affect bargaining power

and the ability of the acquirer to integrate the target into their business (Fuller, Netter, and Stegemoller

2002). Based on prior literature, we expect HOSTILE (Schwert 2000), MULTIBID (Bradley, Desai, and

Kim 1988), and POOLING (Ayers, Lefanowicz, and Robinson 2002), to be positively associated with the

acquisition premium while we expect that DEALRATIO (Fuller, Netter, and Stegemoller 2002) and

SAMEIND (Villalonga 2004) will be negatively associated with the acquisition premium. See the

Appendix for definitions of all variables used in the study.

Table 4 presents results without the control variables (Model 1) and with the aforementioned

control variables (Model 2). The coefficient on the NOL indicator variable (aNOL) in Model 1 is .034 (p<

.01) indicating that on average acquisition premiums are about 3.4% higher when the acquirer has NOLs,

relative to the price paid by non-NOL acquiring corporations. The coefficient on the NOL indicator

variable is .027 (p<.05) in Model 2, indicating that acquisition premiums are about 2.7% higher when the

acquirer has NOLs after controlling for other factors that may affect the acquisition premium. This result

indicates that, controlling for other factors, acquiring firms with NOLs are more likely to pay a higher

premium in the acquisition of profitable targets than acquiring firms without NOLs. With the target’s

average market value of equity being $974 million, these estimates indicate that acquiring firms with

NOLs paid roughly a $26 million higher acquisition premium on average.

The coefficient on STOCK is negative as predicted and statistically significant (p<.01) indicating

that the acquisition premium is lower when acquiring firm stock comprises more than 50% of the

consideration received by target shareholders. As discussed earlier, this can be the result of two effects.

First, higher levels of acquirer stock usage in the transaction increase the likelihood that the acquirer’s

ability to use its NOLs post-acquisition will be limited by I.R.C. Section 382 reducing the potential NOLs

tax benefit. Second, a relatively higher percentage of stock in the deal is a proxy for the deal’s tax status.

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A lower percentage of stock used in the deal increases the likelihood of a taxable transaction, which may

result in a higher acquisition price (premium).

The positive coefficient on HOSTILE is consistent with prior research that finds that acquisition

premiums are higher in hostile transactions. The negative coefficient on MULTIBID is not consistent with

expectations. The positive coefficient on POOLING is consistent with prior research that finds that firms

pay higher acquisition premiums to use the pooling-of-interest accounting method. The negative

coefficient on SAMEIND is consistent with the conclusion that acquisitions of targets within the

acquirer’s industry are completed at a lower premium. The coefficient on DEALRATIO is negative .044

(p< .01), and suggests that when the target corporation is large relative to the acquiring corporation,

acquisition premiums tend to be lower. The coefficients on tROE, tMTB, tLEVERAGE and tREVENUE

are not statistically significant.

The economic benefits of acquirer NOLs are tax savings arising from reduction the level of

taxation on the target firms’ future profits. If these tax savings are a valuable asset to NOL acquiring

corporations, acquisition premiums should be related to a measure of such tax benefits. As such, we

estimate the value of acquirer NOL tax benefits arising from the target’s profits and analyze the

relationship between such tax benefits and acquisition premium. To develop such a measure, we assume

that targets maintain the same level of profits in post acquisition periods.13 We then estimate how many

periods it will take to absorb the acquirer’s NOLs with the target’s profits, and the annual tax savings (at a

35% tax rate) from shielding those future profits from taxation.14 Finally, we estimate the present value of

tax benefits from use of the target’s NOLs based on the periods required to utilize the acquirer’s NOLs

13 This assumes that corporate earnings follow a random walk model as suggested by prior research. Following Hanlon, Laplante, and Shevlin (2005), we estimate taxable income as the sum of current federal tax expense divided by the top U.S. statutory tax rate of 35% less the change in net operating loss carryforward. If current federal expense is missing, we calculate tax expense as the difference between total tax expense and the sum of deferred tax expense, state tax expense, and other tax expense.

14 The maximum number of years for which we estimate tax savings is twenty years based on the current maximum life of NOLs.

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and assuming a 12% discount rate.15 We scale this estimate (TAXBENEFITS) by the target’s pre-

acquisition market value, and label this variable tTAXBENEFITS.

Table 5 contains the results of estimating the effect of tTAXBENEFITS on acquisition premium.

The coefficient on tTAXBENEFITS is .381 (p<.01) in the basic model (Model 1) and .275 (p<.05) in the

specification that includes the aforementioned control variables (Model 2). The coefficient on

tTAXBENEFITS indicates that for a one standard deviation increase in the variable, the acquisition

premium increases by about 1.9%. This result is consistent with the conclusion that acquirer NOL related

tax benefits are positively associated with acquisition premiums. Control variables have similar sign,

magnitude and significance as those in Table 4. In sum, the results in Tables 4 and 5 are consistent with

the conclusion that acquirer NOL status is positively associated with acquisition premiums.

4.2 Acquirer Abnormal Returns

We next examine acquirer abnormal returns in response to the announcement of the acquisition of

the target firm. If the tax benefits of utilizing the acquirer’s NOLs to shield the target’s profits from

taxation are partially captured by the acquirer, then we expect the market response to the acquisition

announcement to reflect those economic benefits.

We estimate acquirer abnormal returns the same way that we estimated target abnormal returns

described above, and acquiring firm abnormal returns in response to the announcement of the acquisition

are reported in Table 6. For all acquisitions, acquirer two-day announcement period abnormal returns are

negative 1% on average, and negative 0.7% at the median. When the acquirer has NOLs, the average

(median) abnormal return is negative 0.3% (negative 0.3%). Turning to acquirers without NOLs, the

average (median) two-day announcement period abnormal return is negative 1.2% (negative 0.8%). A

comparison of acquirer abnormal returns for those acquirers with and without NOLs indicates that

acquirers with NOLs realize higher (less negative) abnormal returns than acquirers without NOLs.

15 The average annualized S&P 500 Index return over our sample period is slightly higher than 10%. We use 12% in our analyses to provide a conservative estimate of the value of the tax benefits of accelerated use of the acquirer’s NOLs.

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Specifically, on average acquirers with NOLs realize about 0.9% higher (less negative) abnormal returns

than acquirers without NOLs (p<.05). Median acquirer abnormal returns are higher (less negative) for

acquirers with NOLs by about 0.5% (p<.01).

To control for other factors that may affect the acquiring firms’ returns, we use the following

model to examine the effects of NOLs on acquirer abnormal returns:

aCAR2it = β0 + β1aNOL + β2 aROE + β3 aMTB + β4 aLEVERAGE + β5 aREVENUE + β6 STOCK + β7

HOSTILE + β8 MULTIBID + β9 POOLING + β10 SAMEIND + β11 DEALRATIO + εit (4)

In equation (4) above, aCAR2 is the acquiring corporation’s two-day (days -1 and 0) abnormal

return and aNOL is an indicator variable equal to 1 when the acquiring corporation has NOLs, zero

otherwise. We expect the acquirer NOL indicator variable to be positively related to acquirer abnormal

returns. Other variables in equation (4) are as previously defined and discussed in equation (3). Based on

prior literature, we expect HOSTILE (Schwert 2000), MULTIBID (Bradley, Desai, and Kim 1988),

POOLING (Ayers, Lefanowicz, and Robinson 2002), and DEALRATIO (Fuller, Netter, and Stegemoller

2002) to be negatively associated with the acquirer abnormal returns while we expect that SAMEIND

(Villalonga 2004) will be positively associated with the acquirer abnormal returns.

Table 7 presents the results of estimating equation (4). In Model 1, the coefficient on aNOL

is .009 (p<.01) indicating that acquirer NOL status is positively related to acquirer abnormal returns. In

Model 2, the coefficient on aNOL is .008 (p<.01) indicating that the abnormal returns for acquiring firms

with NOLs are higher than those of acquiring firms without NOLs by about 0.8% after controlling for

other factors. With the average market capitalization for the acquiring firms being roughly $9,479 million,

the average NOL related tax benefits captured by the acquiring firms are roughly $76 million per firm.

This result is consistent with the conclusion that the market responds more favorably to acquisition by

acquiring firms with NOLs and the response can be attributable to the expectation that acquiring firms

with NOLs capture some of the economic benefit of monetizing acquirer NOLs with target profits.

The coefficient on STOCK is negative consistent with prior research which finds that acquirer

abnormal returns are more negative when the acquirer purchases the target with its stock. This result

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implies that large issues of acquirer stock increases the likelihood that the value of the acquirer’s NOLs

could be impaired due to potential limitation on the use of NOLs imposed under Section 382.16 The

coefficient on POOLING is negative, which suggests that acquirers completing pooling of accounting

acquisitions may be perceived as overpaying. The negative coefficient on DEALRATIO is consistent with

Fuller et al. (2002), which indicates that acquirer abnormal returns are lower when the target corporation

is large relative to the acquiring corporation. The negative coefficients on aROE, and aREVENUE

indicates that higher acquirer profitability is associated with lower acquisition premiums. The negative

coefficient on aMTB indicates that acquirer abnormal returns are negatively associated with the acquirer’s

pre-acquisition market to book ratio.

Similar to the prior analysis of the target firms’ abnormal returns, we also analyze the effect of

the economic benefits of acquiring firms’ NOLs on acquiring firm abnormal returns. We first use the

present value of future tax savings from shielding the target’s profits with the acquirer’s NOLs,

TAXBENEFITS, as estimated in the previous analysis of target firm’s acquisition premium. Then we scale

it by acquirer market value of equity to derive the variable aTAXBENEFITS. The results of the analysis of

NOL tax benefits on acquirer firms’ abnormal returns are reported in Table 8. In Model 1, the coefficient

on aTAXBENEFITS is .498 (p<.01). When the control variables are incorporated in Model 2, the

coefficient on aTAXBENEFITS is .573 (p<.01). The coefficient indicates that for a one standard deviation

increase in aTAXBENEFITS, the acquirer’s abnormal return is about 1.1% higher (less negative). This

result is consistent with the conclusion that tax benefits from accelerated use of acquirer NOLs are

positively associated with acquirer announcement period returns. Control variables have similar sign,

magnitude and significance as those in Table 7.

4.3 I.R.C. Section 382 Limitation

16 As noted previously, use of stock in an acquisition increases the likelihood of “ownership change” (defined in IRC §382) for an acquirer.

15

As noted previously, large issuances of the acquiring firm’s stock may trigger the I.R.C. Section

382 limitation on the acquirer’s NOLs. Because Section 382 can limit the acquiring corporation’s use of

its NOLs, the limitation can reduce or even eliminate the potential tax benefits of acquiring a profitable

target. In this section, we perform additional analyses to examine the subset of firms that may be subject

to the Section 382 limitation.

Section 382 is triggered if there is a 50% change in ownership of the acquirer’s stock during any

three-year period.17 We estimate the triggering of a Section 382 limitation as occurring in transactions

where the estimated value of stock exchanged in the transaction is at least 50% of the acquirer’s market

value twenty trading days (consistent with the start of our estimation period) prior to the announcement

date. The value of stock exchanged is estimated as the percentage of stock used in the transaction

multiplied by the deal value. Based on this estimation, we identified 57 transactions that may be subject to

the Section 382 limitation. We then partition sample firms into three groups: acquirers with no NOLs,

acquirers with NOLs/Section 382 limitation, and acquirers with NOLs/no Section 382 limitation.

The results of univariate tests are presented in Table 9. Acquisition premiums for each subsample

are presented in Panel A. For acquirers without NOLs, the average (median) two-day acquisition

premium is 15.4% (10.2%). The average (median) two-day acquisition premium is 10.4% (7.7%) for

acquirers with NOLs/Section 382 limitation. The average (median) two-day acquisition premium is

20.8% (15.4%) for acquirers with NOLs/no Section 382 limitation. The acquisition premium for this latter

group is also significantly higher (p<.01) than the other two groups (acquirers without NOLs and

acquirers with NOLs/Section 382 limitation). This result also holds when comparing median acquisition

premiums. In sum, when a Section 382 limitation on the acquirer’s NOLs is more likely to be triggered,

we observe lower the acquisition premiums.

Analysis of the effect of Section 382 limitation on the acquiring firms abnormal returns are

presented in Table 9, Panel B. The average (median) two-day abnormal returns for acquiring corporations

17 The analysis and determination of when a Section 382 ownership change occurs is very complex and involves a variety of inputs and tests. The discussion of all of the intricacies of Section 382 is beyond the scope of this paper.

16

without NOLs is -1.2% (-0.8%). The average (median) two-day abnormal returns is negative 1% (-0.5%)

for acquirers with NOLs/Section 382 limitation. The difference in acquirer abnormal return between these

two groups is not significantly different. Acquirers with NOLs/no Section 382 limitation have average

(median) two-day abnormal returns of -0.1% (-0.3%). Acquirer abnormal returns for this latter group are

significantly higher (less negative) that the other two groups of acquiring firms. Overall, these univariate

results are consistent with the conclusion that a potential Section 382 limitation on the acquirer’s NOLs is

associated with a reduction in the acquirer’s announcement period abnormal returns.

Since acquirers with NOLs/Section 382 limitation will not realize the same tax benefits as

acquirers with NOLs/no Section 382 limitation, we repeat our prior multivariate analyses by excluding

the 57 transactions that may be subject to Section 382. Results of the multivariate tests for acquisition

premiums are presented in Table 10. Similar to prior analyses, Model 1 and Model 2 present the results of

estimating the effects of having NOLs while Model 3 and Model 4 presents the results of estimating the

effects of tax benefits, denoted as tTAXBENEFITS (aTAXBENEFITS), on acquisition premiums (acquirer

abnormal returns).

In Table 10, the coefficient on the NOL indicator variable in Model 1 is .054 (p< .01) indicating

that average acquisition premiums are higher when the acquirer has NOLs, relative to the price paid by

acquiring corporations without NOLs. After controlling for other factors potentially affecting the

acquisition premium in Model 2, the coefficient on the NOL indicator variable is .032 (p<.05), indicating

that acquisition premiums are 3.2% higher when the acquirer has NOLs. The coefficient on

tTAXBENEFITS is .443 (p<.01) in Model 3 and .281 (p<.05) in the specification that includes control

variables (Model 4). The coefficient on tTAXBENEFITS in the multivariate specification indicates that for

a one standard deviation increase in the variable, the acquisition premium increases by about 1.9%. In

general, these results suggest that when acquirers with NOLs/Section 382 limitation are removed from the

analysis, the effect of acquirer NOLs on acquisition premiums becomes more pronounced.

Table 11 contains analyses of acquirer abnormal returns. In Model 1, the coefficient on the NOL

indicator variable is .011 (p<.01), which indicates that acquirer NOLs are positively related to acquirer

17

abnormal returns. In Model 2, the coefficient on aNOL is .008 (p<.05) indicating that acquirer abnormal

returns are more positive by about 0.8% when the acquirer has NOLs after controlling for other factors. In

Model 3, the coefficient on aTAXBENEFITS is .513 (p<.01). After adding control variables in Model 4,

the coefficient on aTAXBENEFITS is .506 (p<.01). That coefficient indicates that for a one standard

deviation increase in aTAXBENEFITS, the acquirer’s abnormal return is about 1% higher (less negative).

4.4 Unprofitable Targets

We supplement our primary tests by performing additional analyses using a sample of

acquisitions of unprofitable target firms. Since acquirers with NOLs can use their NOLs more efficiently

when acquiring a profitable target, the prior analyses predict that acquisition premiums and acquirer

abnormal returns are higher for acquirers with NOLs. However, unprofitable targets would not give rise

to such tax benefits to an acquirer with NOLs. As a result, we do not expect acquisitions premiums or

acquirer abnormal returns to be higher when the target is unprofitable or has NOLs.

The results of univariate tests are presented in Table 12. Acquisition premiums for the overall

sample and each NOL subsample are presented in Panel A. For the overall sample, the average (median)

two-day acquisition premium is 19% (11.5%). There is no significant difference in acquisition premium

when the sample is partitioned based on whether or not the acquiring corporation has NOLs. The average

(median) two-day acquisition premium is 19.2% (11.1%) for acquirers with NOLs and 18.9% (11.9%) for

acquirers without NOLs. The difference of 0.3% (negative 0.8%) is not statistically significant at

conventional levels.

Acquirer abnormal returns are presented in Table 12, Panel B. The overall average (median) two-

day abnormal returns for acquiring corporations is -0.8% (-0.5%). The average (median) two-day

abnormal return is -1.3% (-0.6%) for acquirers with NOLs and -0.5% (-0.5%) for acquirers without

NOLs. The difference of 0.8% (0.1%) is significant (p<.05). The univariate results suggest that acquirers

with NOLs earn more negative abnormal returns than acquirers without NOLs when acquiring

unprofitable targets. This result is opposite to the findings reported in Tables 6 and 7. In Tables 6 and 7,

18

the data indicate that NOL acquirers earn higher (less negative) abnormal returns than non-NOL acquirers

when acquiring profitable targets.

Results of multivariate tests are presented in Table 13. We regress the target corporation’s

acquisition premiums on aNOL, an indicator variable equal to one for acquiring firms with NOLs and

zero otherwise, and the same aforementioned control variables. There is no significant association

between acquiring firm NOLs and acquisition premiums of unprofitable targets in Table 13. We also

regress the acquiring corporation’s two-day abnormal returns on aNOL and the same control variables.

Consistent with the univariate results in Table 12, there is a significant (p<.05) negative association

between acquiring firms with NOLs and acquirer abnormal returns. These results indicate that acquirers

with NOLs earn lower abnormal returns of about 0.8% when the target is unprofitable, holding other

factors constant.

Overall, the supplemental tests indicate that acquisitions premiums do not differ between

acquirers with and without NOLs when the target is unprofitable. Further, acquirer abnormal returns are

more negative when the acquirer has NOLs and the target is unprofitable.

4.5 Anecdotal Evidence

In this section, we analyze public disclosures by NOL acquiring corporations for evidence that

acquirer NOL tax effects were an important consideration in the acquisition. In review of our acquisition

sample, we identified several acquiring firms that discussed accelerated use of their NOLs as a result of

acquiring a profitable target. We present such examples below as additional evidence beyond the

traditional empirical analyses discussed above.

In several cases, the acquirer cited utilization of its net operating losses as a reason for and benefit

of the transaction. For example, The Warnaco Group’s January 18, 2000 8-K filing cited cost synergies

and cash flow benefits from the realization of its NOLs in its discussion of the purpose of the merger with

Authentic Fitness Corporation. Warnaco stated the following:

19

“PURPOSE AND STRUCTURE OF THE OFFER AND THE MERGER; REASONS OF WARNACO AND PURCHASER FOR THE OFFER AND THE MERGER

The purpose of the Offer and the Merger is to allow Warnaco and Authentic Fitness, as a combined company to, among other things, (i) achieve operating synergies in the manufacturing, distribution and marketing of their respective products, (ii) effect cost savings in information systems and other areas, (iii) consolidate complementary earnings and cash flow profiles, (iv) utilize Warnaco's net operating losses to reduce taxes and further improve cash flow income, and (v) present a stronger financial profile. In addition, the Merger will allow the elimination of public company costs and duplicative administrative functions.”18

Similarly, Crompton Corporation’s March 9, 2005 press release announcing its acquisition of

Great Lakes Chemical Corporation cited cost synergies and cash flow benefits from use of Crompton’s

NOLs as reasons for how the transaction will improve the combined company’s earnings and cash flow.

“The transaction is expected to be accretive to the combined company's 2006 earnings per share and cash flow per share. In addition to significant cost synergies, the combined company expects to realize cash flow benefits related to utilization of Crompton's net operating losses.”19

Furthermore, in its public filings about the acquisition, Crompton noted that cash flow from the use of its

NOLs made possible by the merger were one of the “Reasons for the Merger.”

“Recommendation of Crompton's Board of Directors and Reasons for the Merger…“Crompton's Reasons for the Merger. In reaching its decision to approve and adopt the merger agreement, Crompton's board of directors consulted with Crompton's management, as well as its financial and legal advisors. Crompton's board of directors considered a number of factors, including, among other things, the following principal positive factors (the order does not reflect relative significance):…Cash Flow Benefit From Use of NOLs—Crompton expects to realize cash flow benefits related to utilization of Crompton's net operating losses made possible by the merger.”20

AES acquired Dayton Power and Light in 2011 for $3.5 billion in cash. At the time, AES had

NOLs of about $1.6 billion. In AES’s conference call with analysts on April 20, 2011, Ned Hall, AES’s

president for North America, stated that “We don’t expect to have any incremental cash taxes as a result

18 Source: Warnaco 8-K dated January 18, 2000. http://www.sec.gov/Archives/edgar/data/801351/000095017200000073/0000950172-00-000073.txt. Emphasis added.

19 Source: Crompton Press Release dated March 9, 2005. http://www.dealipedia.com/deal_view_acquisition.php?r=1047. Emphasis added.

20 Source: Crompton Corporation S-4 dated May 23, 2005. http://www.sec.gov/Archives/edgar/data/1091862/000104746905015496/a2157718zs-4a.htm. Emphasis added.

20

of the acquisition, in that the N.O.L. will absorb the full cash liability that is currently paid to the I.R.S.”21

Similarly, AES’s Proxy Materials state that the transaction was “expected to deliver strong U.S. cash flow

with ability to capture value associated with AES’ U.S. tax position.”22

In 2014, CIT acquired OneWest for about $3.4 billion. At the time, CIT had about $5.2 billion of

NOLs.23 In its presentations to investors, CIT noted that the acquisition would accelerate use of CIT’s

NOLs and that the present value of the acceleration of NOL use was between $300 and $400 million.

“OneWest's operating profitability accelerates the rate at which CIT can utilize its NOL, benefiting cash taxes and regulatory capital, and increasing the present value of the NOL by $300–400 million”24

The presentation labels the source of value as the “Present Value of Accelerating NOL Utilization.”25

In one case, the acquisition documents and the disclosures accompanying the acquisition

documents contained explicit information regarding the effects of the NOL on the negotiated purchase

price. Bethlehem Steel Corporation increased its offer to acquire Lukens Inc. from $25 per share to $30

per share in order to outbid Allegheny Teledyne Incorporated’s $28 per share offer. The January 5, 1998

Bethlehem Steel press release contained the following explanation for the increased offer:

“Bethlehem said there were a number of reasons why the company was able to improve the consideration from its previously signed definitive merger agreement with Lukens to a level superior to Allegheny Teledyne Incorporated's recent $28 per share offer to acquire Lukens. First, the combination will generate identifiable operating and administrative synergies at the high end of the range of synergies that Allegheny Teledyne said it could achieve from its combination with Lukens. In addition, Bethlehem will be able to utilize its significant tax net operating carryforwards to shield Lukens' pre-tax earnings and the pre-tax synergies from its combination with Lukens.26

…

7. Explain the tax benefits to Bethlehem through the proposed merger with Lukens.21 Source: “AES to Buy Ohio Utility for $3.5 Billion,” The New York Times, April 20, 2011.

http://dealbook.nytimes.com/2011/04/20/aes-to-buy-ohio-utility-dpl-in-4-7-billion-deal/22 Source: AES April 20, 2011, DEF14A.

http://www.sec.gov/Archives/edgar/data/874761/000114420411023113/0001144204-11-023113-index.htm23 Source: CIT 10-Q dated August 6, 2014.

http://www.sec.gov/Archives/edgar/data/1171825/000089109214005963/0000891092-14-005963-index.htm24 Source: CIT presentation regarding its acquisition of OneWest, dated July 22, 2014.

http://ir.cit.com/Cache/1500062445.PDF?Y=&O=PDF&D=&fid=1500062445&T=&iid=102820. Emphasis added.25 Source: CIT presentation regarding its acquisition of OneWest, dated July 22, 2014.

http://ir.cit.com/Cache/1500062445.PDF?Y=&O=PDF&D=&fid=1500062445&T=&iid=102820.26 Source: Bethlehem Steel 8-K dated January 14, 1999. http://www.sec.gov/Archives/edgar/data/11860/0000950157-98-

000022.txt. Emphasis added.

21

Answer: Bethlehem has net operating loss carryforwards as a result of losses sustained in previous years. We can use those NOLs to shield Lukens' pre-tax earnings and the pre-tax synergies that would arise from a Bethlehem-Lukens combination. 27

The examples above further support the conclusion that the acquirer’s monetization of its pre-

acquisition NOLs plays a role in the price paid for a target and is a factor associated with acquirer

abnormal returns around the merger announcement.

5. Conclusion

We analyze acquisition premiums paid by acquirers with and without NOLs, and abnormal

returns realized by acquirers with and without NOLs. The evidence supports the conclusion that acquirers

with NOLs pay higher premiums than acquirers without NOLs to acquirer profitable targets. Moreover,

the evidence supports the conclusion that acquirer abnormal returns in response to the acquisition

announcement are positively associated with the tax benefits from accelerated use of the acquirer’s NOLs.

There is no evidence of an acquisition premium or positive association with acquirer abnormal returns

when transactions potentially trigger a Section 382 limitation on the acquirer’s NOLs, or if the target is

unprofitable. Finally, we present several pieces of anecdotal evidence that accelerated use of acquirer

NOLs plays a role in the price paid and expected benefits realized by acquirers in acquisitions.

27 Source: Bethlehem Steel 8-K dated January 14, 1999. http://www.sec.gov/Archives/edgar/data/11860/0000950157-98-000022.txt. Emphasis added.

22

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24

Table 1

Sample Selection

Panel A. Sample Selection ObservationsSDC Platinum Database: Completed acquisitions with U.S. public targets from 1987-2015 12,269 Less: acquisitions of subsidiaries (679)Less: stock buybacks, exchange offers, recapitalizations (4,623)Less: transactions that did not result in a majority stake (1,286)Less: observations that cannot be matched with Compustat and CRSP data (1,919)Completed acquisitions with WRDS data 3,762 Less: unprofitable targets (1,246)Less: targets with net operating losses (490)Less: acquirers with only foreign net operating losses (40)Final sample 1,986

25

Panel B. Sample distribution by yearYear Frequency Percentage1987 45 2.271988 40 2.011989 36 1.811990 20 1.011991 22 1.111992 29 1.461993 39 1.961994 106 5.341995 139 71996 156 7.851997 198 9.971998 173 8.711999 176 8.862000 120 6.042001 94 4.732002 47 2.372003 55 2.772004 81 4.082005 50 2.522006 74 3.732007 65 3.272008 28 1.412009 25 1.262010 19 0.962011 20 1.012012 20 1.012013 34 1.712014 39 1.962015 36 1.81Total 1,986 100

26

Panel C. Sample distribution by industryTarget Acquirer

SIC Industry Frequency Percentage Frequency Percentage1 Agricultural Production - Crops 1 0.05 0 0.002 Agricultural Production - Livestock and Animal Specialties 2 0.10 0 0.007 Agricultural Services 3 0.15 2 0.108 Forestry 1 0.05 1 0.059 Fishing, Hunting and Trapping 1 0.05 0 0.00

10 Metal Mining 2 0.10 2 0.1012 Coal Mining 1 0.05 0 0.0013 Oil and Gas Extraction 36 1.81 35 1.7614 Mining and Quarrying of Nonmetallic Minerals, Except Fuels 2 0.10 1 0.0515 Building Cnstrctn - General Contractors & Operative Builders 8 0.40 10 0.5016 Heavy Cnstrctn, Except Building Construction - Contractors 4 0.20 2 0.1017 Construction - Special Trade Contractors 4 0.20 5 0.2520 Food and Kindred Products 24 1.21 26 1.3121 Tobacco Products 1 0.05 3 0.1522 Textile Mill Products 3 0.15 3 0.1523 Apparel, Finished Prdcts from Fabrics & Similar Materials 10 0.50 9 0.4524 Lumber and Wood Products, Except Furniture 8 0.40 4 0.2025 Furniture and Fixtures 6 0.30 5 0.2526 Paper and Allied Products 9 0.45 10 0.5027 Printing, Publishing and Allied Industries 17 0.86 15 0.7628 Chemicals and Allied Products 53 2.67 72 3.6329 Petroleum Refining and Related Industries 4 0.20 4 0.2030 Rubber and Miscellaneous Plastic Products 10 0.50 8 0.4031 Leather and Leather Products 3 0.15 0 0.0032 Stone, Clay, Glass, and Concrete Products 5 0.25 8 0.4033 Primary Metal Industries 18 0.91 27 1.3634 Fabricated Metal Prdcts, Except Machinery & Transport Eqpmnt 23 1.16 13 0.6535 Industrial and Commercial Machinery and Computer Equipment 71 3.58 84 4.2336 Electronic, Elctrcl Eqpmnt & Cmpnts, Excpt Computer Eqpmnt 83 4.18 68 3.4237 Transportation Equipment 29 1.46 32 1.6138 Mesr/Anlyz/Cntrl Instrmnts; Photo/Med/Opt Gds; Watchs/Clocks 90 4.53 96 4.8339 Miscellaneous Manufacturing Industries 9 0.45 10 0.5040 Railroad Transportation 5 0.25 4 0.2042 Motor Freight Transportation 14 0.70 8 0.4044 Water Transportation 1 0.05 1 0.0545 Transportation by Air 6 0.30 8 0.4047 Transportation Services 5 0.25 4 0.2048 Communications 60 3.02 77 3.8849 Electric, Gas and Sanitary Services 89 4.48 94 4.7350 Wholesale Trade - Durable Goods 29 1.46 25 1.2651 Wholesale Trade - Nondurable Goods 17 0.86 27 1.3652 Building Matrials, Hrdwr, Garden Supply & Mobile Home Dealrs 3 0.15 2 0.1053 General Merchandise Stores 9 0.45 16 0.8154 Food Stores 11 0.55 12 0.6055 Automotive Dealers and Gasoline Service Stations 1 0.05 0 0.0056 Apparel and Accessory Stores 7 0.35 5 0.2557 Home Furniture, Furnishings and Equipment Stores 6 0.30 5 0.2558 Eating and Drinking Places 11 0.55 9 0.4559 Miscellaneous Retail 17 0.86 13 0.6560 Depository Institutions 700 35.25 702 35.3561 Nondepository Credit Institutions 27 1.36 5 0.2562 Security & Commodity Brokers, Dealers, Exchanges & Services 28 1.41 16 0.8163 Insurance Carriers 48 2.42 76 3.8364 Insurance Agents, Brokers and Service 3 0.15 4 0.2065 Real Estate 1 0.05 4 0.2067 Holding and Other Investment Offices 43 2.17 68 3.4270 Hotels, Rooming Houses, Camps, and Other Lodging Places 8 0.40 13 0.6572 Personal Services 4 0.20 2 0.1073 Business Services 181 9.11 156 7.8575 Automotive Repair, Services and Parking 1 0.05 0 0.0076 Miscellaneous Repair Services 2 0.10 0 0.0078 Motion Pictures 8 0.40 0 0.0079 Amusement and Recreation Services 8 0.40 5 0.2580 Health Services 62 3.12 48 2.4282 Educational Services 1 0.05 1 0.0583 Social Services 1 0.05 3 0.1587 Engineering, Accounting, Research, Management & Related Svcs 28 1.41 18 0.91

Total 1,986 100 1,986 100

27

TABLE 2

Descriptive Statistics for Samples and Subsamples Based on theAcquiring Corporations’ Tax Attributes (unscaled amounts in $ millions)

N Mean Std Dev Q1 Median Q3

Panel A: All firmsaTLCF 1,986 44.955 224.401 0.000 0.000 0.000aNOL 1,986 0.152 0.359 0.000 0.000 0.000TAXBENEFIT 1,986 3.833 17.638 0.000 0.000 0.000tTAXBENEFIT 1,980 0.009 0.034 0.000 0.000 0.000aTAXBENEFIT 1,983 0.002 0.009 0.000 0.000 0.000tROE 1,931 0.157 0.272 0.074 0.126 0.186tMTB 1,914 3.503 6.151 1.302 1.950 3.041tLEVERAGE 1,918 0.815 1.261 0.029 0.411 1.068tREVENUE 1,916 0.204 0.332 0.035 0.118 0.252tMV 1,965 973.536 2,725.298 56.170 158.061 587.534aROE 1,962 0.159 0.261 0.108 0.162 0.218aMTB 1,945 4.272 6.667 1.726 2.534 4.331aLEVERAGE 1,959 1.042 1.446 0.209 0.613 1.307aREVENUE 1,952 0.267 0.443 0.047 0.145 0.322aMV 1,962 9,478.886 23,981.959 440.637 1,586.792 6,172.565STOCK 1,986 0.620 0.486 0.000 1.000 1.000HOSTILE 1,986 0.019 0.135 0.000 0.000 0.000MULTIBID 1,986 0.048 0.213 0.000 0.000 0.000POOLING 1,986 0.269 0.443 0.000 0.000 1.000SAMEIND 1,986 0.705 0.456 0.000 1.000 1.000DEALRATIO 1,957 0.428 0.554 0.071 0.214 0.552DEALVALUE 1,981 1,406.735 3,660.891 92.337 259.732 867.678

N Mean Std Dev Q1 Median Q3Panel B: Acquirer – Without NOLaTLCF 1,685 0.000 0.000 0.000 0.000 0.000aNOL 1,685 0.000 0.000 0.000 0.000 0.000TAXBENEFIT 1,685 0.000 0.000 0.000 0.000 0.000tTAXBENEFIT 1,685 0.000 0.000 0.000 0.000 0.000aTAXBENEFIT 1,685 0.000 0.000 0.000 0.000 0.000tROE 1,632 0.157 0.251 0.076 0.126 0.181tMTB 1,619 3.327 5.863 1.275 1.868 2.868tLEVERAGE 1,622 0.840 1.214 0.057 0.456 1.110tREVENUE 1,620 0.199 0.331 0.033 0.114 0.248tMV 1,670 955.852 2,743.980 52.864 145.287 534.635aROE 1,663 0.166 0.234 0.116 0.164 0.216aMTB 1,648 4.115 6.154 1.727 2.476 4.194aLEVERAGE 1,662 1.050 1.386 0.227 0.647 1.322aREVENUE 1,654 0.255 0.42 0.046 0.143 0.299aMV 1,664 9,487.862 24,638.309 447.409 1,532.847 5,542.771STOCK 1,685 0.651 0.477 0.000 1.000 1.000HOSTILE 1,685 0.020 0.139 0.000 0.000 0.000MULTIBID 1,685 0.047 0.213 0.000 0.000 0.000POOLING 1,685 0.280 0.449 0.000 0.000 1.000SAMEIND 1,685 0.723 0.448 0.000 1.000 1.000DEALRATIO 1,660 0.401 0.522 0.070 0.205 0.523DEALVALUE 1,681 1,363.295 3,632.559 88.700 235.210 790.075

28

N Mean Std Dev Q1 Median Q3Panel C: Acquirer – With NOLaTLCF 301 296.613 *** 508.225 14.187 67.000 *** 282.200aNOL 301 1.000 *** 0.000 1.000 1.000 *** 1.000TAXBENEFIT 301 25.290 *** 38.911 1.963 6.446 *** 26.629tTAXBENEFIT 295 0.059 *** 0.069 0.009 0.031 *** 0.077aTAXBENEFIT 298 0.013 *** 0.019 0.001 0.005 *** 0.017tROE 299 0.158 0.367 0.058 0.126 0.214tMTB 295 4.472 ** 7.475 1.570 2.556 *** 4.293tLEVERAGE 296 0.681 * 1.488 0.000 0.168 *** 0.760tREVENUE 296 0.233 0.338 0.054 0.134 ** 0.333tMV 295 1,073.649 2,619.282 84.018 257.824 *** 838.750aROE 299 0.123 * 0.375 0.038 0.154 *** 0.225aMTB 297 5.142 * 8.962 1.683 3.004 ** 5.565aLEVERAGE 297 0.998 1.747 0.069 0.444 *** 1.052aREVENUE 298 0.337 ** 0.546 0.049 0.153 * 0.403aMV 298 9,428.762 19,959.521 358.116 2,014.700 8,547.944STOCK 301 0.445 *** 0.498 0.000 0.000 *** 1.000HOSTILE 301 0.013 0.115 0.000 0.000 0.000MULTIBID 301 0.050 0.218 0.000 0.000 0.000POOLING 301 0.206 *** 0.405 0.000 0.000 *** 0.000SAMEIND 301 0.608 *** 0.489 0.000 1.000 *** 1.000DEALRATIO 297 0.584 *** 0.688 0.088 0.300 *** 0.869DEALVALUE 300 1,650.139 3,812.862 134.704 390.622 *** 1,368.230

All balance sheet and income statement variables are as of the end of the most recent fiscal year prior to the earlier of the announcement or effective date of the transaction. aTLCF is the acquiring firm’s net operating loss. aNOL is an indicator variable for net operating losses, which is equal to one if the acquirer has a tax loss carryforward greater than zero and zero otherwise. TAXBENEFIT is the present value of 35% of target firm taxable income as an annuity with a 12% discount rate and acquiring firm NOL divided by target firm taxable income with a maximum of 20 as the time of cash flow. tTAXBENEFIT is the expected tax benefits from accelerated use of acquiring firm net operating losses scaled by target firm market value. aTAXBENEFIT is the expected tax benefits from accelerated use of acquiring firm net operating losses scaled by acquirer firm market value. tROE is the target firm return on equity. tMTB is the target market-to-book ratio. tLEVERAGE is the target firm leverage defined as long-term debt divided by beginning of year total common equity. tREVENUE is the target firm’s average revenue growth over the previous two years. tMV is the target firm market value of equity. aROE is the acquiring firm return on equity. aMTB is the acquiring market-to-book ratio. aLEVERAGE is the acquiring firm leverage defined as long-term debt divided by beginning of year total common equity. aREVENUE is the acquiring firm’s average revenue growth over the previous two years. aMV is the acquiring firm market value of equity. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. DEALVALUE is the total deal value as reported by SDC Platinum. Continuous variables used in the regression analyses are winsorized at 1% and 99% to mitigate outliers.

***,**, and * indicate that the difference between the two groups of firms is significant at the 1, 5, and 10 percent levels in a two-tail test, respectively. We use the t-test for the mean and the Wilcoxon two-sample test for the median.

29

TABLE 3

Abnormal Returns for Target Corporations

All FirmsAcquirers

With NOLsAcquirers

Without NOLs DifferenceMean Median Mean Median Mean Median Mean Median

tCAR1 0.142 0.085 0.167 0.111 0.137 0.083 0.030 ** 0.028 **tCAR2 0.160 0.106 0.189 0.139 0.154 0.102 0.035 *** 0.037 ***

tCAR1 is the target firm 1-day (day 0) abnormal returns. tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* indicates that the difference between the two groups of firms is significant at 1%, 5%, and 10%, respectively, in a two-tail test. We use the t-test for the mean and the Wilcoxon two-sample test for the median.

30

TABLE 4

Estimate of the Effect of Acquirer NOL Status on Target Acquisition Premium During 1987-2015(t-stat in parentheses)

tCAR2 = β0 + β1aNOL + Controls + ε

Independent Variable Predicted Sign Model 1 Model 2

Intercept 0.1543 (32.99)

*** 0.2426 (22.26)

***

aNOL + 0.0344(2.86)

*** 0.0274 (2.21)

**

tROE -0.0283(-1.3)

tMTB -0.0009(-0.89)

tLEVERAGE -0.0007(-0.19)

tREVENUE -0.0176(-1.19)

STOCK - -0.0654(-6.29)

***

HOSTILE + 0.0653(2.05)

**

MULTIBID + -0.0329(-1.59)

POOLING + 0.0002(0.02)

SAMEIND - -0.0194(-2.0)

**

DEALRATIO - -0.0435(-5.33)

***

R2 0.004 0.063F-stat 8.18 *** 11.37 ***Observations 1,977 1,863

tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. aNOL is an indicator variable for net operating losses, which is equal to one if the acquirer has a tax loss carryforward greater than zero and zero otherwise. tROE is the target firm return on equity. tMTB is the target market-to-book ratio. tLEVERAGE is the target firm leverage defined as long-term debt divided by beginning of year total common equity. tREVENUE is the target firm’s average revenue growth over the previous two years. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* Significant at 1%, 5%, and 10%, respectively.

31

TABLE 5

Estimate of the Effect of Expected Tax Benefits on Target Acquisition Premium During 1987-2015(t-stat in parentheses)

tCAR2 = β0 + β1tTAXBENEFIT + Controls + ε

Independent Variable Predicted Sign Model 1 Model 2

Intercept 0.1563(35.1)

*** 0.2444 (22.78)

***

tTAXBENEFIT + 0.3814(3.01)

*** 0.2754(2.11)

**

tROE -0.0325(-1.49)

tMTB -0.0007(-0.66)

tLEVERAGE -0.0010(-0.26)

tREVENUE -0.0178(-1.21)

STOCK - -0.0660(-6.36)

***

HOSTILE + 0.0628 (1.97)

**

MULTIBID + -0.0347(-1.68)

*

POOLING + 0.0002(0.02)

SAMEIND - -0.0197 (-2.03)

**

DEALRATIO - -0.0418(-5.15)

***

R2 0.005 0.063F-stat 9.03 *** 11.33 ***Observations 1,972 1,863

tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. tTAXBENEFIT is the expected tax benefits from accelerated use of acquiring firm net operating losses scaled by acquiring firm market value in target return analyses. tROE is the target firm return on equity. tMTB is the target market-to-book ratio. tLEVERAGE is the target firm leverage defined as long-term debt divided by beginning of year total common equity. tREVENUE is the target firm’s average revenue growth over the previous two years. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* Significant at 1%, 5%, and 10%, respectively.

32

TABLE 6

Abnormal Returns for Acquiring Corporations

All FirmsAcquirers

With NOLsAcquirers

Without NOLs DifferenceMean Median Mean Median Mean Median Mean Median

aCAR1

-0.010 -0.006 -0.003 0.000 -0.011 -0.007 0.008 ** 0.007 ***

aCAR2

-0.010 -0.007 -0.003 -0.003 -0.012 -0.008 0.009 ** 0.005 ***

aCAR1 is the acquiring firm 1-day (day 0) abnormal returns. aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* indicates that the difference between the two groups of firms is significant at 1%, 5%, and 10%, respectively, in a two-tail test. We use the t-test for the mean and the Wilcoxon two-sample test for the median.

33

TABLE 7

Estimate of the Effect of Acquirer NOL Status on Acquirer Abnormal Return During 1987-2015(t-stat in parentheses)

aCAR2 = β0 + β1aNOL + Controls + ε

Independent Variable Predicted Sign Model 1 Model 2

Intercept -0.0118 (-9.81)

*** 0.0027 (0.97)

aNOL + 0.0091(2.94)

*** 0.0081 (2.58)

***

aROE -0.0061 (-1.36)

aMTB -0.0005(-2.52)

**

aLEVERAGE 0.0002(0.23)

aREVENUE -0.0027(-0.98)

STOCK - -0.0117(-4.47)

***

HOSTILE - 0.0019(0.24)

MULTIBID - 0.0005(0.10)

POOLING - -0.0114(-3.98)

***

SAMEIND + 0.0029(1.18)

DEALRATIO - -0.0070(-3.41)

***

R2 0.004 0.057F-stat 8.67 *** 10.46 ***Observations 1,982 1,925

aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. aNOL is an indicator variable for net operating losses, which is equal to one if the acquirer has a tax loss carryforward greater than zero and zero otherwise. aROE is the acquiring firm return on equity. aMTB is the acquiring market-to-book ratio. aLEVERAGE is the acquiring firm leverage defined as long-term debt divided by beginning of year total common equity. aREVENUE is the acquiring firm’s average revenue growth over the previous two years. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* Significant at 1%, 5%, and 10%, respectively.

34

TABLE 8

Estimate of the Effect of Expected Tax Benefits on Acquirer Abnormal Return During 1987-2015 (t-stat in parentheses)

aCAR2 = β0 + β1aTAXBENEFIT + Controls + ε

Independent Variable Predicted Sign Model 1 Model 2

Intercept -0.0114 (-10.02)

*** 0.0036 (1.31)

aTAXBENEFIT + 0.4985(3.93)

*** 0.5734 (4.41)

***

aROE -0.0054 (-1.21)

aMTB -0.0005(-2.53)

**

aLEVERAGE 0.0000(0.06)

aREVENUE -0.0019(-0.7)

STOCK - -0.0122(-4.7)

***

HOSTILE - 0.0003(0.04)

MULTIBID - 0.0006(0.12)

POOLING - -0.0110(-3.86)

***

SAMEIND + 0.0031(1.25)

DEALRATIO - -0.0089(-4.22)

***

R2 0.008 0.063F-stat 15.44 *** 11.69 ***Observations 1,979 1,925

aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. aTAXBENEFIT is the expected tax benefits from accelerated use of acquiring firm net operating losses scaled by acquiring firm market value in target return analyses. aROE is the acquiring firm return on equity. aMTB is the acquiring market-to-book ratio. aLEVERAGE is the acquiring firm leverage defined as long-term debt divided by beginning of year total common equity. aREVENUE is the acquiring firm’s average revenue growth over the previous two years. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* Significant at 1%, 5%, and 10%, respectively.

35

TABLE 9

Cross-Sectional Analysis with Section 382 Limitation

Panel A: Abnormal Returns for Target Corporations

Acquirers Without NOLs

Acquirers With NOLs & Section 382 Limitation

Acquirers With NOLs(No Section 382 Limitation)

Mean Median Mean Median Mean Median

tCAR1 0.137 0.083 0.077 *** 0.054 ** 0.188 *** 0.130 ***tCAR2 0.154 0.102 0.104 *** 0.077 0.208 *** 0.154 ***

Panel B: Abnormal Returns for Acquiring Corporations

Acquirers Without NOLs

Acquirers With NOLs & Section 382 Limitation

Acquirers With NOLs(No Section 382 Limitation)

Mean Median Mean Median Mean Median

aCAR1

-0.011 -0.007 -0.017 -0.002 0.001 *** 0.000 ***

aCAR2

-0.012 -0.008 -0.010 -0.005 -0.001 *** -0.003 ***

The triggering of a Section 382 limitation is defined as transactions where the estimated value of stock exchanged in the transaction is at least 50% of the acquirer’s market value 20 trading days prior to the announcement date. The value of stock exchanged is estimated as the percentage of stock used in the transaction multiplied by the deal value. tCAR1 is the target firm 1-day (day 0) abnormal returns. tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. aCAR1 is the acquiring firm 1-day (day 0) abnormal returns. aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* indicates that the difference between the acquirers without NOL and the acquirers with NOL (with and without the Section 382 limitation) is significant at 1%, 5%, and 10%, respectively, in a two-tail test. We use the t-test for the mean and the Wilcoxon two-sample test for the median.

36

TABLE 10

Effect of NOL Status on Target Acquisition Premium, Excluding Firms with Section 382 Limitation (t-stat in parentheses)

tCAR2 = β0 + β1aNOL + Controls + εtCAR2 = β0 + β1tTAXBENEFIT + Controls + ε

Independent Variable Model 1 Model 2 Model 3 Model 4

Intercept 0.1543 (32.87)

*** 0.2400 (21.36)

*** 0.1577(34.84)

*** 0.2432 (22.16)

***

aNOL 0.0539(4.08)

*** 0.0320 (2.33)

**

tTAXBENEFITs 0.4425(3.31)

*** 0.2810(2.04)

**

tROE -0.0357(-1.55)

-0.0387(-1.68)

*

tMTB -0.0007(-0.65)

-0.0005(-0.43)

tLEVERAGE -0.0001(-0.03)

-0.0004(-0.09)

tREVENUE -0.0181(-1.21)

-0.0184(-1.23)

STOCK -0.0637(-5.93)

*** -0.0654(-6.13)

***

HOSTILE 0.0625(1.92)

* 0.0595 (1.83)

*

MULTIBID -0.0311(-1.48)

-0.0325(-1.54)

POOLING -0.0002(-0.02)

0.0001(0.01)

SAMEIND -0.0171(-1.72)

* -0.0177 (-1.78)

*

DEALRATIO -0.0437(-5.07)

*** -0.0433(-5.02)

***

R2 0.009 0.062 0.006 0.061F-stat 16.66 *** 10.71 *** 10.98 *** 10.59 ***Observations 1,921 1,811 1,917 1,811

tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. aNOL is an indicator variable for net operating losses, which is equal to one if the acquirer has a tax loss carryforward greater than zero and zero otherwise. tTAXBENEFIT is the expected tax benefits from accelerated use of acquiring firm net operating losses scaled by acquiring firm market value in target return analyses. tROE is the acquiring firm return on equity. tMTB is the acquiring market-to-book ratio. tLEVERAGE is the acquiring firm leverage defined as long-term debt divided by beginning of year total common equity. tREVENUE is the acquiring firm’s average revenue growth over the previous two years. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

37

***,**,* Significant at 1%, 5%, and 10%, respectively.

38

TABLE 11

Effect of NOL Status on Acquirer Abnormal Returns, Excluding Firms with Section 382 Limitation (t-stat in parentheses)

aCAR2 = β0 + β1aNOL + Controls + εaCAR2 = β0 + β1aTAXBENEFIT + Controls + ε

Independent Variable Model 1 Model 2 Model 3 Model 4

Intercept -0.0118 (-10.14)

*** 0.0023 (0.83)

-0.0112 (-10.04)

*** 0.0033 (1.23)

aNOL 0.0109(3.31)

*** 0.0075 (2.27)

**

aTAXBENEFITS 0.5134(3.35)

*** 0.5064 (3.28)

***

aROE -0.0011 (-0.25)

-0.0011 (-0.23)

aMTB -0.0005(-2.7)

*** -0.0005(-2.77)

***

aLEVERAGE 0.0002(0.21)

0.0000(-0.01)

aREVENUE -0.0041(-1.54)

-0.0034(-1.27)

STOCK -0.0119(-4.61)

*** -0.0121(-4.75)

***

HOSTILE 0.0002(0.03)

-0.0016(-0.2)

MULTIBID -0.0003(-0.06)

-0.0001(-0.02)

POOLING -0.0109(-3.88)

*** -0.0107(-3.82)

***

SAMEIND 0.0036(1.49)

0.0035(1.44)

DEALRATIO -0.0077(-3.66)

*** -0.0090(-4.2)

***

R2 0.006 0.062 0.006 0.065F-stat 10.98 *** 11.26 *** 11.21 *** 11.8 ***Observations 1,925 1,871 1,924 1,871

aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. aNOL is an indicator variable for net operating losses, which is equal to one if the acquirer has a tax loss carryforward greater than zero and zero otherwise. aTAXBENEFIT is the expected tax benefits from accelerated use of acquiring firm net operating losses scaled by acquiring firm market value in target return analyses. aROE is the acquiring firm return on equity. aMTB is the acquiring market-to-book ratio. aLEVERAGE is the acquiring firm leverage defined as long-term debt divided by beginning of year total common equity. aREVENUE is the acquiring firm’s average revenue growth over the previous two years. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* Significant at 1%, 5%, and 10%, respectively.

39

TABLE 12

Additional Analysis for Unprofitable Targets

Panel A: Abnormal Returns for Target Corporations

All FirmsAcquirers

With NOLsAcquirers

Without NOLs DifferenceMean Median Mean Median Mean Median Mean Median

tCAR1 0.174 0.091 0.178 0.099 0.171 0.088 0.007 0.011tCAR2 0.190 0.115 0.192 0.111 0.189 0.119 0.003 -0.008

Panel B: Abnormal Returns for Acquiring Corporations

All FirmsAcquirers

With NOLsAcquirers

Without NOLs DifferenceMean Median Mean Median Mean Median Mean Median

aCAR1

-0.010 -0.005 -0.016 -0.008 -0.006 -0.004 -0.010 *** -0.004 ***

aCAR2

-0.008 -0.005 -0.013 -0.006 -0.005 -0.005 -0.008 ** -0.001 *

tCAR1 is the target firm 1-day (day 0) abnormal returns. tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. aCAR1 is the acquiring firm 1-day (day 0) abnormal returns. aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* indicates that the difference between the two groups of firms is significant at 1%, 5%, and 10%, respectively, in a two-tail test. We use the t-test for the mean and the Wilcoxon two-sample test for the median.

40

TABLE 13

Effect of NOL Status on Target Acquisition Premium and Acquirer Abnormal Returns, Unprofitable Targets (t-stat in parentheses)

CAR2 = β0 + β1aNOL + Controls + ε

Independent Variable Model 1:tCAR2

Model 2:tCAR2

Model 3:aCAR2

Model 4:aCAR2

Intercept 0.1887 (19.26)

*** 0.2648 (14.29)

*** -0.0053 (-2.38)

** 0.0032 (0.79)

aNOL 0.0035(0.21)

-0.0126 (-0.72)

-0.0082(-2.18)

** -0.0082 (-2.16)

**

ROE -0.0023(-0.31)

-0.0001 (-0.04)

MTB 0.0000(-0.04)

0.0000(0.26)

LEVERAGE -0.0055(-1.73)

* 0.0024(2.28)

**

REVENUE -0.0007(-0.23)

-0.0031(-2.42)

**

STOCK -0.0806(-4.32)

*** -0.0148(-3.68)

***

HOSTILE -0.0237(-0.22)

0.0292(1.33)

MULTIBID -0.0613(-1.51)

0.0063(0.69)

POOLING -0.0120(-0.43)

-0.0011(-0.19)

SAMEIND 0.0089(0.49)

-0.0003(-0.07)

DEALRATIO -0.0621(-3.69)

*** -0.0028(-0.76)

R2 0.000 0.047 0.004 0.036F-stat 0.05 4.78 *** 4.76 ** 3.83 ***Observations 1,229 1,068 1,243 1,151

tCAR2 is the target firm 2-day (days -1 and 0) abnormal returns. aCAR2 is the acquiring firm 2-day (days -1 and 0) abnormal returns. aNOL is an indicator variable for net operating losses, which is equal to one if the acquirer has a tax loss carryforward greater than zero and zero otherwise. ROE is the target (acquiring) firm return on equity in target (acquiring) firm analyses. MTB is the target (acquiring) market-to-book ratio in target (acquiring) firm analyses. LEVERAGE is the target (acquiring) firm leverage defined as long-term debt divided by beginning of year total common equity in target (acquiring) firm analyses. REVENUE is the target (acquiring) firm’s average revenue growth over the previous two years in target (acquiring) firm analyses. STOCK is an indicator variable equal to one if the percentage of stock used in the transaction is greater than or equal to 50% and zero otherwise. HOSTILE is an indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise. MULTIBID is an indicator variable equal to one if there are multiple bidders for the target and zero otherwise. POOLING is an indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise. SAMEIND is an indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise. DEALRATIO is the deal value scaled by the acquiring firm’s market value of equity. Continuous variables are winsorized at 1% and 99% to mitigate outliers.

***,**,* Significant at 1%, 5%, and 10%, respectively.

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Appendix

Variable definitions – Variables of Interest

tCAR1 Target firm 1-day (day 0) abnormal returns

tCAR2 Target firm 2-day (days -1 and 0) abnormal returns

aCAR1 Acquiring firm 1-day (day 0) abnormal returns

aCAR2 Acquiring firm 2-day (days -1 and 0) abnormal returns

aNOL Indicator variable for net operating losses, which is equal to one if the acquiring firm has a domestic tax loss carryforward greater than zero and zero otherwise

tTAXBENEFIT Expected tax benefits from accelerated use of acquiring firm net operating losses (TAXBENEFIT) scaled by target firm market value in target return analyses

aTAXBENEFIT Expected tax benefits from accelerated use of acquiring firm net operating losses (TAXBENEFIT) scaled by acquiring firm market value in acquirer return analyses

TAXBENEFIT Present value of 35% of target firm taxable income discounted at a 12% discount rate. The number of periods in the present value estimation is calculated as the acquiring firm NOL divided by target firm taxable income with a maximum of 20 years. Taxable income is defined as the sum of current federal tax expense divided by the top U.S. statutory tax rate of 35% less the change in net operating loss carryforward. If current federal is missing, tax expense is the difference between total tax expense and the sum of deferred tax expense, state tax expense, and other tax expense (in millions)

Variable definitions – Control Variables

aLEVERAGE Acquiring firm leverage defined as long-term debt divided by beginning of year total common equity (in millions)

aMTB Acquiring firm market-to-book ratio defined as market capitalization divided by beginning of year total common equity

aMV Acquiring firm market value of equity computed as the number of common shares outstanding (in millions) at year-end multiplied by price (dollars and cents)

aREVENUE Acquiring firm average revenue growth between year 0 and year -2, where year 0 is the year prior to the acquisition

aROE Acquiring return on equity defined as net income before extraordinary items divided by beginning of year total common equity

aTLCF Acquiring firm’s net operating loss (in millions)

DEALRATIO Deal value as reported by SDC Platinum (in millions) scaled by the acquiring firm’s market value of equity

DEALVALUE Total deal value as reported by SDC Platinum (in millions)

HOSTILE Indicator variable equal to one if the deal was unsolicited or hostile and zero otherwise

MULTIBID Indicator variable equal to one if there are multiple bidders for the target and zero otherwise

POOLING Indicator variable equal to one if the acquiring firm used the pooling of interests accounting method in a tax-free exchange of stock and zero otherwise

SAMEIND Indicator variable equal to one if the acquiring firm and target firm share the same 2-digit SIC and zero otherwise

STOCK Indicator variable equal to one if the percentage of stock used in the transaction is greater

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than or equal to 50% and zero otherwise

tLEVERAGE Target firm leverage defined as long-term debt divided by beginning of year total common equity (in millions)

tMTB Target firm market-to-book ratio defined as market capitalization divided by beginning of year total common equity

tMV Target firm market value of equity computed as the number of common shares outstanding (in millions) at year-end multiplied by price (dollars and cents)

tREVENUE Target firm average revenue growth between year 0 and year -2, where year 0 is the year prior to the acquisition

tROE Target return on equity defined as net income before extraordinary items divided by beginning of year total common equity

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