Risk Management and Value Creation in ... - Arabictrader.com

Rationales for Risk Management in Banks 119
After-Tax
Income
Hedged
e(X)
Pretax
Income
Low E(X) High
Unhedged
Figure 3.10 Effects of convex tax schedules on after-tax income.
Source: Adapted from Smithson et al. (1995), p. 104.
■
Alternative minimum tax (e.g., difference between reported and taxable
income)
The increases in the progressivity of the tax code have only limited
applicability to corporations, 347 because there is only a narrow range of
marginal corporate tax rates, 348 which make this argument only a weak
motive for conducting risk management. 349 However, the other arguments—
such as, for example, the presence of tax preference items—are much more
likely to apply and can make the effective tax rates convex 350 despite the
limited progressivity of corporate tax rates. The convexity of the tax function
is, therefore, plausible, especially when firms face a significant prob-
347 This is especially true for large publicly quoted banks.
348 See Mason (1995), p. 30.
349 See Fenn et al. (1997), p. 18.
350 Graham and Smith (1996) examine the degree of convexity of the tax function in
the United States. For most corporations the tax function is convex due to tax-loss
carry forwards. However, for some corporations, Graham and Smith observe a concave
tax function.