The Effect of Succession Taxes on Family Firm Investment: Evidence from a Natural Experiment

by Margarita Tsoutsoura

University of Chicago Booth School of Business
Chicago Booth Research Paper No. 12-15
December 11, 2011

This paper exploits a natural experiment to study the effect of succession taxes on firm succession and investment decisions. The experiment is made possible by the Greek government’s decision to abolish its high tax on intra-family transfers of businesses in 2002. This change in tax policy is used to identify the effect on investment using two methodologies: 1) A difference-in-difference-in-differences (DDD) methodology, and 2) an instrumental variables (IV) approach, which exploits the gender of the first-born child of the departing entrepreneur as an instrument for family successions. Both the DDD and the IV estimates show that in the presence of high succession taxes firms undergoing an intra-family transfer of ownership experience a more than 40% drop in investment around succession. High succession taxes are also associated with lower propensity for intra-family succession, slow total asset growth and a depletion of cash reserves (presumably used to pay taxes) for firms experiencing family successions. To identify the mechanism through which taxes affect investment, I collect data on the income of the entrepreneurs from sources other than the firm undergoing succession. I find that the investment effects are much stronger for family firms owned by entrepreneurs with relatively low income from other sources. This suggests that the observed effect of the succession tax on investment is driven by financial constraints.

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