The litigation of tax benefit preservation plans

Abstract

Purpose The authors study the shareholder wealth effects of the adoption and subsequent litigation confirming the validity of shareholder right plans that are enacted to protect a firm’s net operating loss (NOL) carry forwards (tax benefit preservation plans (TBPPs)). The purpose of this paper is to expand the understanding of nontraditional shareholder rights plans, which are becoming increasingly more common. Design/methodology/approach This paper considers abnormal returns around TBPP adoptions and Delaware Court rulings that validated their use. The authors study 118 plans adopted between 1998 and 2011. Abnormal returns are measured using both a market model and a performance-matched sample. Findings The authors find that abnormal returns are negative at the announcement of a new TBPP. However, the full impact of plan adoption on share prices is not evident until the Delaware Courts validated their use. The Delaware Court rulings in the case of Selectica, Inc. v. Versata Enterprises, Inc. and Trilogy, Inc. are associated with additional negative wealth effects for both prior plan adopters and the firms most likely to consider adopting a plan. These results suggest that entrenchment concerns tend to outweigh the protection of NOL carry forwards when firms adopt TBPPs. Originality/value This study was the first to consider the adoption of TBPPs. Currently, it is the only study that considers Delaware Court rulings related to these plans, which allows us to successfully disentangle the entrenchment hypothesis from the potential alternative hypothesis that the negative announcement period returns are driven by investors updating their expectations for firm performance.