Conservative accounting yields excessive risk-taking - a note

In this note we analyze the role of business taxation for corporate risk-taking under different accounting principles (such as mark-to-market, lower-of-cost-or-market and historical cost). We demonstrate that conservative accounting may imply incentives to overinvest in risky assets. If tax loss offset opportunities are less than perfect, the market-to-market principle penalizes risky investment whereas more conservative accounting leaves the risk choice unaffected.