We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers' educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities.

We hypothesize and find evidence consistent with foreign firms being tax-favored acquirers of U.S. targets with greater locked-out earnings because they can avoid the U.S. tax on repatriations. This effect is economically significant; a standard deviation increase in lockout is associated with a 12% relative increase in the likelihood that an acquirer is foreign. We also find evidence that foreign acquirers of the target firms are more likely to be residents of countries that use territorial tax systems, as the tax advantages for a foreign firm acquiring a U.S. target with locked-out earnings are even greater for these acquirers.

We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers' educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities.