This study provides a model explaining how tax rate changes could affect corporate decisions on the spending of entertainment expenditures(EE). This study further test empirically the theoretical results drawn from analyzing the model. In the theoretical analysis, it is shown that the optimal EE of the firms for which its dollar amount falls below the deductible ceiling stipulated in the tax law(low-EE firms, henceforth) is determined independently of tax rates(in other words, the optimal EE of such firms is neutral to tax rates), but that the optimal EE of the firms for which its amount exceeds the ceiling (high-EE firms, henceforth) is dependent upon tax rates(that is, the optimal EE of such firms are not tax-neutral). In particular, a reduction in tax rate results in an increase in the optimal EE because a tax rate reduction lowers the tax disfavor of the EE that exceeds the deductible ceiling. To empirically test these theoretical results, this study analyzes the EE of the years in which tax rates fell, 2002 and 2005, as compared to those of the prior years, 2001 and 2004 for both low-EE firms and high-EE firms. The major empirical results found in this study are as follows. First, consistent with the theoretical prediction, high-EE firms increase the EE in the years of tax rate reductions relative to the previous years. On the other hand, while in 2002 low-EE firms do not increase the EE relative to 2001, they increase the spending of the EE in 2005 relative to 2004. This study provides one potential reason for the low-EE firms’ increase in the EE in 2005. When tax rates decline, it is optimal for high-EE firms to expand the spending of their EE because the tax cost of the EE declines (in particular, the tax cost of the EE in excess of the deductible ceiling). Expanding the EE would, in turn, enhance their competitiveness, resulting in an increase in their market share. This means that the market share of low-EE firms in the same industry would decline. Because it would not be optimal for low-EE firms to acquiesce to a decline in their market share, they would have to increase the spending of the EE as their competitors do. If this is the case, an increase in the high-EE firms’ spending of the EE triggered by tax rate reductions would give rise to an increase in low-EE firms’ spending. While the 2005 increase in low-EE firms’ spending could be explained by the competitive nature of the corporate decisions, the null effect in the 2002 cannot. However, it is likely that because the magnitude of the tax rate fall of 2005 is twice as large as that of 2002, high-EE firms’ spending would be much greater in 2005 than in 2002. So the possibility may have been escalated in 2005 that high-EE firm's spending of more EE stimulates low-EE firms to mimic them. The second major empirical result is that high-EE firms with higher sales growth rates tend to increase the EE spending to a greater extent in the years of tax rate reductions than those with low sales growth rates. This empirical phenomenon is clearly observed in each of the two years of tax rate reductions, seemingly independent of the magnitude of the tax rate reduction. In contrast, a similar phenomenon is not observed consistently for low-EE firms. In 2002, low-EE firms having high sales growth rates exhibit the tendency to increase the EE to a greater extent, but on the contrary, firms with low sales growth rates show the tendency to increase the spending more in 2005. In sum, corporate decisions with respect to the optimal EE in response to tax rate reductions seem more consistent in the case of high-EE firms than in the case of low-EE firms. This supports indirectly the theoretical finding that the optimal EE of low-EE firms is neutral to tax rates, while the high-EE firms’ optimal EE varies with tax rates. In summary, this study has theoretically demonstrated that when tax rates fall, corporate incentives to adjust the optimal EE differ, depending on whether it is a high-EE or a low-EE firm. It has also empirically shown that the EE spending of high-EE firms rises as tax rates go down. To the extent that the rise of the EE contributes to an increase in the value of the spending firms, this study has documented the effectiveness of such tax policies as decreases in tax rates. Further, this study also reports that an increase in the EE varies with firms’ sales growth rates, implying that the marginal revenue of the EE spending may also vary with firm and/or industry characteristics. It may thus be more desirable to adopt a policy of differing ways of determining the deductible ceiling of the EE in accordance with the productivity of the EE spending rather than the uniform policy we currently have. Besides such policy implications, this study contributes to the existing EE-related literature in that it has rigorously modelled corporate decisions on the optimal EE spending, and thus expand the understanding of the corporate decision making