Role of personal taxes in capital structure decisions: Evidence from India

Abstract

The study investigates the role of personal taxes in corporate financing decisions and its impact on the corporate tax advantage of debt in domestic manufacturing companies in India. Incremental financing decisions have been analyzed through pooled cross section of time series data on 288 firms from 1989-2011. The effect of personal taxes is captured through two different methods; in one specification marginal tax rates have been adjusted for personal tax penalty and in the other, effect of personal taxes has been captured separately. Results reveal a strong effect of relative personal tax disadvantage of debt on leverage decisions of Indian firms. After including personal taxes, marginal taxes become insignificant. The study also documents that the specification considering the individual effects of corporate and personal taxes is found to be better than the one which adjusts corporate taxes for personal tax penalty.