Does tax convexity matter for risk? A dynamic study of tax asymmetry and equity beta

  • Adrian C. H. Lei
  • Martin H. Y. Yick
  • Keith S. K. Lam
Original Research


The purpose of this study is to explore the effect of tax convexity on firms’ market risk, where tax convexity measures the progressivity of firms’ tax function. We examine the relation between equity beta and tax convexity based on a standard contingent-claims model, in which firms face nonlinear tax schedules. We verify that in the presence of default and growth options, the effect of tax convexity on beta is significant and depends on several countervailing forces. Tax convexity has a direct, positive effect on beta, as well as two indirect countereffects through default and growth options. The overall effect is ambiguous and quantitatively significant. As asymmetric tax schedules are used in most countries, assuming a linear tax schedule in the valuation framework may misestimate beta and thus fail to assess risk accurately. Our theoretical model shows that tax convexity should be taken into consideration when estimating equity beta.


Equity beta Tax convexity Growth option Default option Contingent-claim model 

JEL Classification




We would like to thank an anonymous referee and the editor (Lee, Cheng-Few) for their valuable suggestions, which greatly improved the paper. We thank Deng Jie for her excellent research assistance. We gratefully acknowledge financial support from the University of Macau.


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Copyright information

© Springer Science+Business Media, LLC 2012

Authors and Affiliations

  • Adrian C. H. Lei
    • 1
  • Martin H. Y. Yick
    • 2
  • Keith S. K. Lam
    • 1
  1. 1.Department of Finance and Business Economics, Faculty of Business AdministrationUniversity of MacauMacauChina
  2. 2.Department of Finance and Insurance, Faculty of BusinessLingnan University of Hong KongHong KongChina

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