Abstract
In this paper, we analyze the effect of investor level taxes, firm-specific ownership structure and firm-specific dividend payout policy on a firm’s capital structure choice. Our analysis is based on data for 10,003 firms from 11 Central and Eastern European (CEE) countries over the period 2002–2012. Our results show a significant positive impact from the net tax benefit of debt on the debt ratio of a firm. Ignoring firm heterogeneity, an increase in the net tax benefit of debt by 10 percentage points leads to an increase in the debt ratio of 2.68 percentage points. If we add firm-specific ownership to the analysis, the effect of investor level taxes on the debt ratio is about 1.55 times higher if the firm is wholly owned by a domestic individual investor. For the same type of firm, the effect nearly doubles if we also consider firm-specific dividend payout policy.
Highlights
Since Modigliani and Miller (1958), the effect of taxes on the capital structure of a firm has been under ongoing investigation
We analyze the effect of investor level taxes on capital structure choice and control for firm heterogeneity using firm-specific ownership structure and firm-specific dividend payout policy
If we consider investor level taxes and do not control for firm heterogeneity, we find an increase in the net tax benefit of debt of 10 percentage points to lead to an increase in debt ratios by 2.68 percentage points
Summary
Since Modigliani and Miller (1958), the effect of taxes on the capital structure of a firm has been under ongoing investigation. We analyze the effect of investor level taxes on capital structure choice and control for firm heterogeneity using firm-specific ownership structure and firm-specific dividend payout policy. We show that the effect of investor level taxes on debt ratios increases if we consider firm-specific ownership, consistent with a reduction in measurement error. If firms are majority-owned by a domestic individual, controlling jointly for firm-specific ownership and firm-specific dividend payout policy increases the effect of the net tax benefit of debt on debt ratios by 38%. We enhance prior research by analyzing whether controlling for firm heterogeneity yields a more precise measure of the effect of investor level taxes on debt ratios.
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