Substitution Of Debt Research Articles

Borrowing and Spending in the Money: Debt Substitution and the Cash-out Refinance Channel of Monetary Policy

We show that the strong negative effect of higher mortgage rates on cash-out refinancing reflects substitution into other borrowing products, not large changes in total new household borrowing. We exploit an exogenous increase in long-term rates to show that, in the cross-section of outstanding mortgage rates, changes in cash-out and alternative borrowing are offsetting. Additionally, we instrument using monetary policy surprises to show that, over the period from 2006-2021, changes in cash-out refinancing are offset by alternative borrowing. Our results suggest that debt substitution substantially weakens the cash-out refinance channel of monetary policy and reduces its path-dependence.

The effect of board of directors’ expertise and tax avoidance on corporate debt

AbstractThis study examines the effect of board of directors’ expertise and tax avoidance on corporate debt. We find that there is no association between financially expert outside directors on the board and corporate debt, which is contrary to some prior research findings. However, we do find a positive association between the proportion of financially expert inside directors on the board and debt. We also find that the debt substitution effect is significantly intensified by the presence of outside directors on the board with financial expertise, which suggests that the advice offered by these directors better informs managers to make decisions about the trade‐off between the benefits and costs of debt and non‐debt tax shields. We find no such effect for inside directors. Overall, this study extends the literature on corporate governance, tax avoidance and corporate debt.

Corporate Tax Avoidance, Debt Ratio, and Corporate Governance: Evidence from Japan

This study examines whether tax avoidance is associated with corporate debt policy. Specifically, this study investigates the influence of bond investors and financial institutions such as the banks, which are long-term loan owners, on corporate governance (CG) to determine comprehensively the relationship between tax avoidance and debt ratio. Note that, the financial institutions in Japan have a larger role in indirect finance policies, relative to in the European and U.S. financial markets, and that the financial institutions of the other Asian nations seem to take on the same level of responsibility as those of Japan. This study firstly investigates the association between debt ratio and corporate tax avoidance. Secondly, we examine the influence of effectiveness of debt governance on debt ratio and CG. Thirdly, we focus on the representative tools, such as outside directors and auditors for CG and corporate tax avoidance. Finally, we test the influence of the main banks on this effect because, in addition to their monitoring role, main banks also play a significant advisory role and are thus likely to be in a better position to make superior decisions about a firm's optimal debt and capital structure mix. According to the main result of this study, it seems that the debt enhancement effect is more dominant than the debt substitution effect in Japanese firms. When tax avoidance increases, firms’ profitability rise. Thus, considering the ability to afford a loan from a financial institution, the firms can borrow more. With regard to interactive effects among CG, debt policy, and tax avoidance, we find the CG of firms strengthens when they carry out tax avoidance. If the outside director ratio increases, then the monitoring function of the debtholders improves due to the enhancement of CG functions, and our result suggests that the financial institutions in Japan achieve an effective monitoring function.

Bailing Out the People? When Private Debt Becomes Public

This paper documents a form of private sector bailout that is much more common (and yet unnoticed) than the typical bank bailout. Building on the newly-created Global Debt Database, we show that excess private debt systematically turns into higher public debt, regardless of whether the credit boom resulted in a crisis or a more orderly deleveraging process. This debt migration operates mainly through growth rather than explicit bailouts: private deleveraging weighs on activity, prompting a countercyclical government response to support economic activity. Ultimately, whether this debt substitution results in a net increase or a net decline of overall indebtedness in the economy depends on the extent of the growth slowdown during the deleveraging spell. These findings suggest that markets and policymakers should move away from looking at private and sovereign debt in silos and pay closer attention to the total stock of debt in the economy, as the line between the two tends to become blurry.

Bailing Out the People? When Private Debt Becomes Public

This paper documents a form of private sector bailout that is much more common (and yet unnoticed) than the typical bank bailout. Building on the newly-created Global Debt Database, we show that excess private debt systematically turns into higher public debt, regardless of whether the credit boom resulted in a crisis or a more orderly deleveraging process. This debt migration operates mainly through growth rather than explicit bailouts: private deleveraging weighs on activity, prompting a countercyclical government response to support economic activity. Ultimately, whether this debt substitution results in a net increase or a net decline of overall indebtedness in the economy depends on the extent of the growth slowdown during the deleveraging spell. These findings suggest that markets and policymakers should move away from looking at private and sovereign debt in silos and pay closer attention to the total stock of debt in the economy, as the line between the two tends to become blurry.

Corporate Tax Avoidance and Debt Policy

This paper examines the relation between corporate tax avoidance and debt policy using a large sample of firms from 1988 to 2006. We use modified measures of book-tax difference and long-run cash effective tax rate to proxy for tax avoidance. Using both measures we find consistent evidence that tax avoidance is negatively associated with leverage ratio. Further, we find that the substitution of non-debt tax avoidance for debt dissipates for very large, highly profitable firms, and firms with higher credit rating. Our findings are robust to alternative measures of leverage. Consistent with the debt substitution hypothesis, we offer new evidence to show that tax is an important factor in corporate capital structure decisions.

Do Equity Tax Shields Reduce Leverage? The Austrian Case

The goal of this article is to analyze the impact of equity tax shields, that were allowed in Austria from 2000 to 2004, on the capital structure of Austrian firms, both at book values and at market values. We see that the choice of the leverage ratio determines whether or not one can find an impact of equity tax shields on the capital structure of firms. Precisely, equity tax shields reduce the long-term liabilities to assets ratio and on the long-term liabilities to long-term capital ratio, but have no impact on the total liabilities to assets ratio. Although the Austrian system granted only a rather small dose of equity tax shields, we find that the tax regime achieved its goal to reduce the leverage (ignoring short-term liabilities). Interestingly, even though it is the book value capital structure that determines the size of equity tax shields, this effect was slightly stronger and more significant for the capital structure at market values than for the book value capital structure. We find that the government could influence the capital structure by changing the level of the equity interest rate allowed. We observe that small firms reduced their capital structure more in response to equity tax shields than big firms. Similarly, we find that firms that were included in the Austrian Traded Index (ATX) did not react to equity tax shields. By contrast, firms that were not included in the ATX strongly reacted to the equity tax shields. Moreover, we find that financial firms did not react to the equity tax shields whereas non-financial firms showed at least some reaction. In addition, with this equity tax shield regime we find strong evidence against the debt substitution hypothesis of De Angelo/Masulis (1980).

Capital Structure and Equity Liquidity

This paper investigates the relationship between capital structure and stock liquidity surrounding pure leverage recapitalizations. A substitution of debt for equity in the firm's capital structure concentrates private information in the remaining equity, increasing the informational asymmetry of the firm's equity, leading to increases in the firm's equity liquidity costs. Changes in the firm's leverage are associated with both changes in the probability of informed trading in the firm's stock and with changes in the firm's underlying equity liquidity even after controlling for changes in the commonly used liquidity, equity volatility, or capital structure choice control variables. In aggregate, leverage increasing firms experience an increase of 1% in the bid-ask spread and leverage decreasing firms experience a decrease of 2% in the bid-ask spread. We argue that leverage's effect on equity liquidity costs represents an economically relevant cost to debt usage, and this cost potentially reduces firm value relative to a zero transaction costs environment.

French Manufacturing Firms and the Capital Gap Since 1985 : A Credit Rationing Approach

s: An earlier study (Cieply, Paranque, 1996) revealed the existence of a size effect in the determination of the financial structures of French firms over the period 1990-1993. However, this effect only appeared clearly above the 2000 employee threshold and was not sufficient to identify the dominant factors explaining the financial structures observed. We therefore turned to a model that included the determinants of the demand for and supply of financial debt. The main findings of this research are: the importance of credit rationing by demand over the period as a whole and across the population of firms; the absence of any effect of substitution of debt to suppliers for debt to financial institutions, perhaps due to a lack of information about the customers of firms subject to credit rationing by supply; the high frequency of firms with financial links subject to credit rationing by supply, which doubtless corresponds to specific methods for managing cash balances and the production cycle; the fact that listed firms are more often in equilibrium than other firms. The hypothesis of a small business capital gap is borne out only for the smallest businesses, especially as regards long-term debt. However, this finding is not entirely clear-cut. Lastly, the prevalence of each configuration seems to depend more on the movement of interest rates than on their spread.

The nonequivalence between deficits and distortionary taxation

This paper examines how relaxing the assumption of lump-sum taxation affects the Ricardian equivalence theorem. In a model with income taxation instead of lump-sum taxation structural deficit finance causes Keynesian-like effects even though government bonds are not perceived as net wealth. A temporary substitution of debt for taxation significantly increases consumption, work and output initially — the same effects as in the Keynesian case where the implied future tax liability is not perceived. But in contrast to the Keynesian case, investment also increases initially. In the long run, however, deficit finance significantly reduces investment, work, output and consumption.

How efficient is the substitution of debt for taxes in influencing demand?

A 52-country macro-theoretic model is developed in order to test the Ricardian view that debt and tax finance are equivalent. The alternative traditional view is that government expenditures financed by tax revenue affect the economy in profoundly different ways than expenditures financed by bond issuance. A rigorous testing of the model indicates that a present value-preserving transfer of income from future generations affects the consumption of the current generations in a positive (for solvent countries) or negative (for debt-ridden countries) way. An explanation for this divergence in consumer's behaviour is attempted via the concept of debt illusion.

Fiscal Effectiveness and Debt Illusion in a Rational Expectations Model

The question of how substitution of debt for taxes affects private sector wealth and consumption has long been an unresolved macroeconomic theory and policy dispute. The present study attempts to address this problem within a modified fiscal-illusion setting, by utilizing an explicit rational expectations optimizing model of consumer behaviour for a sample of six developed countries. The empirical evidence pre sented is strongly supportive of the assertion that consumers make their consumption decisions without regard to the future tax implications of a current expansion in government debt at low levels of public sector indebtedness. At high levels of debt-GNP ratios, however, consumers tend to fully discount the future tax obligations implicit in an expansionary debt-financed fiscal policy. L'efficacite fiscale et I'illusion de 1'endettement dans un modele d'anticipations rationnelles.

HOW RIVAL ARE THE RICARDIAN EQUIVALENCE PROPOSITION AND THE FISCAL POLICY POTENCY VIEW?

Substitution of debt for taxes as a means of financing a given path of government expenditure would, according to the Ricardian equivalence proposition, have no important real consequences; yet it could, according to the traditional Keynesian view, have desirable countercyclical and growth effects. A reconciliation of these opposing views is not impossible if the author illuminates a source of deviation from the equivalence theorem, which has not been explored so far: the possibility that consumption decisions in each country are affected by the level of its indebtedness, when private agents operate under a debt illusion. The paper finds, within an explicit intertemporal optimization framework, strong empirical support for the debt-illusion hypothesis in a large sample of 52 countries. Copyright 1992 by Scottish Economic Society.

Business decisions and managerial risk; a note on the decision analysis approach

A difficult lesson for managers to learn is the importance of evaluating risk in financial decision-making. Risk associated with the substitution of debt for equity in the firm's capital structure is a determining factor in financial decision-making. In this paper, an instructive model incorporating the structure of decision analysis is developed in order that managers may visualize clearly the monetary loss and gain associated with different debt to equity ratios. This model in turn permits the interpretation of risk in monetary terms.

Modeling and Testing Ricardian Equivalence: A Survey

Ricardian Equivalence states that, under certain circumstances and for a given path of expenditures, the substitution of debt for taxes does not affect private sector wealth and consumption. Ricardian Equivalence is based on the premise that debt financing is only a change in the timing of taxation that has no impact on private sector consumption if the present value of the stream of taxation remains unchanged. This paper provides a model that illustrates the implications of Ricardian Equivalence, surveys the relevant literature, and considers the effects of relaxing the basic assumptions. It also critically reviews recent empirical work on Ricardian Equivalence.

Debt and distortionary taxation in a simple perfect foresight model

We examine the real effects of a temporary substitution of debt for distortionary income taxation. We find that such a policy may reduce consumption, increase investment, and reduce interest rates. These results arise even though we examine the same model used by Barro, where temporary substitution of debt for lump-sum taxes was shown to have no real effects. We show that these anti-Keynesian effects on consumption are as significant as various pro-Keynesian effects, such as finite lives. Hence, the impact of debt is an empirical issue and Ricardian neutrality appears to be a reasonable benchmark.

Modelling and Testing Ricardian Equivalence: A Survey

Ricardian Equivalence states that, under certain circumstances and for a given path of expenditures, the substitution of debt for taxes does not affect private sector wealth and consumption. Ricardian Equivalence is based on the premise that debt financing is only a change in the timing of taxation that has no impact on private sector consumption if the present value of the stream of taxation remains unchanged. This paper provides a model that illustrates the implications of Ricardian Equivalence, surveys the relevant literature, and considers the effects of relaxing the basic assumptions. It also critically reviews recent empirical work on Ricardian Equivalence.

Barro on the Ricardian Equivalence Theorem

Is public debt issue equivalent to taxation? This is an age-old question in public finance theory. David Ricardo presented the case for the affirmative.1 Professor Robert J. Barro reexamines the question in his recent paper (1974) without, however, making reference to Ricardo or other early contributors. Although his discussion is carefully qualified to allow for exceptions under specified conditions, the thrust of Barro's argument supports the Ricardian theorem to the effect that taxation and public debt issue exert basically equivalent effects. Barro's central emphasis is on demonstrating that, under reasonable conditions which involve overlapping generations of persons with finite lives, taxpayers will capitalize the future obligations that public debt issue embodies. To the extent that this capitalization occurs, government bonds do not add to the perceived net wealth in the economy. From this Barro infers that the substitution of debt for tax finance will exert no expansionary effect on total spending. There are two questions here. Are the future tax liabilities fully capitalized? And, even if they are, does this necessarily imply that the fiscal policy shift exerts no effect on total spending? To establish the second result, it is necessary to examine the differential impacts of taxation and debt issue, quite apart from the question of the capitalization of future taxes. Barro wholly neglects this necessary part of any comparative analysis of the two fiscal instruments, and, because of this neglect, his conclusion is not nearly so relevant for policy as it seems to be. This neglect may stem from Barro's failure to specify properly the inclusive set of transactions that debt issue represents.

Testing the Existence of the Ricardian Equivalence in Ghana in this 21st Century

The Ricardian Equivalence Hypothesis formulated by a classical British economist David Ricardo argues that a reduced tax now is a tax increase in the future, the substitution of debt for current taxes has no effect on aggregate demand. The main objective of this paper is to examine empirically the existence of the Ricardian equivalency in Ghana by using time series data running from 1990 to 2017 and ARDL bound testing approach to cointegration and Error Correction Model framework developed by Pesaran and Shin (1995,1999). We examined the long run relationship between the dependent variable household final consumption expenditure and independent variables government expenditure, deficit, GDP per capita and gross debt. The long run results showed a positive and significant relationship between GDP per capita and household consumption expenditure. The result of analysis supports the Keynesian conventional theory and found strong evidence against the existence of the Ricardian Equivalency Hypothesis in Ghana.