Tax Options and Corporate Capital Structures

Abstract

Among the elements of value reflected in the prices of corporate securities are the taxtiming options associated with the opportunities for investors to tax manage their portfolios by deferring gains and taking losses. We show that the aggregate value of these taxtiming options for the securityholders of a firm will be enhanced when the firm has multiple classes of tradeable securities outstanding. For that reason, the inclusion of debt as well as equity in a firm's capital structure should raise the total market value of the firm. We further show that, under most likely circumstances, there will be an interior optimal degree of leverage that will maximize tax-timing option values.