Corporate Taxation as an Option and the Idea of Delta Hedging

Summary

The document frames corporate profit taxation as an option-like exposure: tax is owed when earnings are positive, while losses do not generate an equivalent tax benefit. On that view, the government holds a call-like claim on company profits, leaving the firm with an exposure that the author wonders whether it could hedge using techniques from derivatives markets.

Possible corporate actions raised include increasing leverage or repurchasing shares in a publicly traded company. The question also recognizes that these choices may change the firm’s value and therefore alter the exposure to be hedged; the potential lack of a fixed endpoint, apart from bankruptcy, adds complexity. No research references, hedge construction, calculations, or evidence are provided. The material is best read as a research question about applying delta-hedging concepts to corporate finance, not as a demonstrated hedging strategy.

Key ideas

• Asymmetric taxation of profits and losses can be represented as an option-like corporate exposure.
• The document asks whether leverage or share repurchases could hedge that exposure.
• A proposed hedge may change company value and therefore change the exposure itself.
• No references or evidence are supplied to show that these actions provide an effective hedge.

Tags

# Delta hedging of tax option


# Delta hedging of tax option












So corporate profits are taxed as a percentage of the positive earning, but losses will not generate any taxes. Hence taxation have a clear option structure where the government has a call option on the profits generated by the company.

Has there been any research on delta hedging this negative delta exposure from this tax option? For example increasing the leverage of the firm or (for publicly traded companies) by stock repurchase. Of course the hedging will change the value of the underlying and thus in turn change the amount needed to be hedged, which makes the problem somewhat complicated. Also there is no definite end point (only stops at bankruptcy).

This seems like an interesting area of research, but I could not find any references to it online. Are there any other areas (besides standard derivative trading) where techniques for delta hedging have been applied?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.