Irreversible Investment Decisions Under Uncertainty with Tax Holidays

Abstract

This article investigates how a corporate tax holiday affects a firm's incentive to invest when irreversibility interacts with uncertainty. The firm has a monopoly right to exercise a single, discrete, infinitely lived project. After exercising the project, at each instant, the firm receives one unit of output while incurring a fixed amount of operating and maintenance costs. The firm can temporarily and costlessly both shut down and resume its operation. A more generous tax incentive (i.e., a longer tax holiday or a lower corporate tax rate) will discourage a firm's incentive to invest if the firm's value from delaying investment is increased by more than its value of investing immediately. This is more likely to happen if capital assets either are shortlived or yield a return that is very volatile.