Debt Tax Shield Research Articles

Company Life Cycle and Capital Structure of Manufacturing Sector In the Consumer Goods Industry

Determination of the optimal capital structure is to be done by each company Capital structure is the balance or ratio between foreign capital and equity capital. One proxy of capital structure is leverage. The well-known theory in determining the leverage or capital structure is the pecking order theory. This theory explains that the company will use the funds to have a safer risk in advance in the determination of corporate leverage. There are many variables that affect the determination of a company's leverage, so it has not acquired a standard model in determining the leverage or capital structure of the company. One variable that will be added to add an explanation of the determination of a company's leverage is the life cycle proposed by Dickinson (2011). Company life cycle differentiated by the company's cash flow includes cash flow from operating, financing, and investment. This study aims to determine whether the company life cycle that can explain the determination of leverage or capital structure of the company, and find out how the influence of other variables such as profitability, liquidity, size of firm, non debt tax shield, asset tangibility, and growth opportunities for determination of leverage or capital structure of the company. The study was conducted in the consumer goods sector companies in 2012 and 2013. This study uses regression with dummy variables. The results showed that in 2012 and 2013 variable life cycle can be one of the variables that can explain leverage the company's decision. Variables that affect the leverage is profitability, liquidity, non debt tax shield, asset tangibility, and growth opportunities. Variable has no effect on leverage is size of the company.

IMPLIKASI PERUBAHAN UNDANG–UNDANG PERPAJAKAN TERHADAP KEPUTUSAN STRATEGI LEVERAGE BAGI PERUSAHAAN YANG TERDAFTAR DI PT. BURSA EFEK JAKARTA

This research examines the connection between non debt tax shield and the change of leverage, between level of effective company tax and the change of leverage, and between operation income before depreciation and the change of leverage.This research takes 17 samples of food and beverages companies listed in Jakarta Stock Exchange from 1st January 1994 till 31st December 1999. And this research uses data from 1994 – 1999 for the regression analysis. Multiple regression analysis is used to test hyphothesis 1 (H1), hyphothesis 2 (H2) and hyphothesis 3 (H3). Independent variables in the regression are level of effective company tax, non debt tax shield and operation income before depreciation, whilst independent variable in the regression is leverage.The result of this research proves that (1) non debt tax shield after the amendment of 1994 tax regulation (1995 – 1999) brings positive influence to the leverage change, (2) level of effective company tax after the amendment of 1994 tax regulation (1995 – 1999) brings negative influence to the leverage change, and (3) operation income before depreciation after the amendment of 1994 tax regulation (1995 – 1999) brings positive influence to the leverage change.

Corporate social responsibility and degrees of operating and financial leverage

We examine the relationship between corporate social responsibility (CSR) and firms’ degrees of operating (DOL) and financial leverage (DFL). Combining the enlightened value maximizing and capital structure theories, we hypothesize that CSR as firms’ strategic choice to internalize the cost from implicit contracts between the firms and their non-investing stakeholders affects firms’ operating and financial leverage. We find empirical evidence that CSR and CSR strengths are positively (negatively) related to firms’ DOL (DFL). CSR concerns are positively related firms’ DOL and DFL. We also document that CSR is positively related to firms’ operating cost and we find evidence that CSR acts as a substitute for corporate debt tax shield when firms’ financial leverage is low.

The Role of Taxes and the Interdependence Among Corporate Financial Policies: Evidence from a Natural Experiment

In this paper, we investigate whether and how firms respond to an exogenous tax variation at the investor level by examining their financial decisions following a tax reform for pension funds in Brazil. Consistent with the tax-preference theory of dividends, we find that after implementation of the new law, firms tend to distribute more tax-deductible dividends - called Interest on Equity (IOE) - when the largest or second largest shareholder is a pension fund rather than other types of agents. Surprisingly, control firms also increased (but less than treated firms) their tax-deductible dividend payments, probably to attract more institutional investors and to reduce their cost of capital. We also find that treated firms reduced their leverage relative to control firms after the new law, suggesting that equity tax shields and debt tax shields act as substitute financial instruments. Overall, our evidence suggests that tax is a first-order determinant of corporate financial decisions and firms adjust their policies in consideration of the interdependence among alternative financial instruments.

On the value and determinants of the interest tax shields

We use a dynamic model of the firm to ascertain both the value and the determinants of the debt tax shields. For a representative U.S. firm, we find that the value of the interest tax shields represents less than 5 % of firm value, and it varies considerably across U.S. industries. Our results also show that this component of firm value behaves counter-cyclically over the business cycle. Finally, besides the interest rate on debt and the corporate income tax rate, we find that the curvature of the production function is one of the main determinants of the tax advantage of debt.

ВЛИЯНИЕ КОРПОРАТИВНОГО НАЛОГА НА ПРИБЫЛЬ И УРОВНЯ МАРКЕТИЗАЦИИ НА СТРУКТУРУ КАПИТАЛА ПУБЛИЧНЫХ КОМПАНИЙ КИТАЯ

Using the 2008 corporate income tax reform as an opportunity, this paper constructs a Panel DID model to study the effect of corporate income tax and the degree of marketization on capital structure. Based on the 2008 Enterprise Income Tax Reform in China, accompanying with both rise and fall in the tax rate, the paper tests the adaptability of the Modigliani & Miller theory, and develops a capital structure theory in the context of China. Author’s used the financial data of 206 Chinese listed companies from 2002 to 2012. The financial data of listed companies were mainly taken from Xenophon database and GuoTaian database. The marketization index data were obtained from The Marketization Index in China: 2011 Report for the Relative Marketization Process in Various Regions. Industries was classified according to the Global Industry Classification Standard (GICS) and test the sensitivity of the capital structure to exogenous corporate tax rate change in different industries. The empirical results show that: firstly, the higher the degree of marketization is, the more significant the tax shield effect is; secondly, compared to the corporate income tax, differences in the degree of marketization exert a more significant effect on the corporate capital structure; thirdly, because of the long existence of tax incentives, debt tax shield is not significant in people’s livelihood industries and information technology industry; Fourthly, given the upward trend in the overall asset-liability ratio of Chinese companies, in order to control companies’ financial risk, we recommend to foster market reform and the use corporate income tax incentives where necessary. The results of research will provide a reference for future marketization reform and tax policies in different industries in China.

How to Consider Excess Cash in Firm Valuation

In this short working paper I show a possible way of considering excess cash in firm valuation, using a simplified numerical example. Existing various theories about the way to discount the debt's tax shield, I adopt Harris & Pringle theory which discounts the tax savings at the unlevered cost of equity Ku. Netting debt with excess cash does not provide a right valuation of the firm. Instead, gross debt must be used.

Determinants of Capital Structure – A study of selected Pharma Companies

Capital structure is fundamentally permanent long term financing of a firm. The objectives of this study are to identify the significant determinants of capital structure of the listed Pharmaceutical companies in NSE/BSE during the period 1999–2013. In relation to the study determinants are considered are profitability, tangibility, growth, size, debt service capacity, tax rate, non debt tax shields, financial leverage cost of debt and cost of equity. The study uses correlations and multiple regression analysis, to find the relationship between Debt-equity ratio (i.e., Dependent variable) and determinants of capital structure (independent variables), The policy implication is that the financial managers should consider these determinants as yardsticks before taking the leverage decisions in order to choose the most favorable capital structure for the company so that it maximizes the shareholders’ value.

On the Value and Determinants of the Interest Tax Shields

We use a dynamic model of the firm to ascertain both the value and the determinants of the debt tax shields. For a representative U.S. firm, we find that the value of the interest tax shields represents less than 3% of firm value, and it varies considerably across U.S. industries. Our results also show that this component of firm value behaves counter-cyclically over the business cycle. Finally, besides the interest rate on debt and the corporate income tax rate, we find that the curvature of the production function is one of the main determinants of the tax advantage of debt.

Tax reforms and the capital structure of banks

The paper studies the link between corporate income tax reforms and domestic bank entities' financing decisions. We use a dataset of corporate income tax (CIT) reforms and estimate the effect of tax rate changes on leverage, dividend policies and earnings management of banks using BankScope (Orbis) data. Our results suggest that taxation influences all three variables in the first three years after the reform. Leverage increases with the CIT rate. The reason is that the statutory CIT rate determines the value of the debt tax shield. A higher tax rate increases incentives to use debt finance when interest payments are deductible from the CIT base. Also, dividend pay-outs increase after an increase of CIT rates. This could indicate that banks actively manage their pay-out policies around tax reforms and adjust their capital structure with changes in dividends. Furthermore, banks increase loss loan reserves in anticipation of a tax rate cuts since losses become less valuable with lower CIT rates. In the context of the current regulatory reform in the financial sector which focuses strongly on improving equity ratios of banks, our results suggest that future tax policies should focus on eliminating the favorable treatment of debt in general and for banks in particular. The reason is that this distortion at least partly undermines the regulatory objectives of increasing (regulatory) capital.

How Much Do Private Equity Funds Benefit From Debt‐related Tax Shields?

In 2008 the German government enacted a measure designed to curb excessive leverage in LBOs by limiting tax‐deductible interest to 30% of EBITDA. And in the U.S., legislators are currently reviewing several regulatory measures, including limits on tax‐deductible interest, that are intended to reduce the leverage of portfolio companies in U.S. LBO funds.In their recent study of 56 German LBOs transacted after the tax law change in 2008, the authors analyze the importance of debt‐related tax savings and the economic consequences of their reduction for the PE business model. The study begins by confirming that LBO debt tax shields are a material component of LBO purchase prices, contributing as much as 20% of the average estimated total enterprise value. At the same time, however, the study finds that the effects on LBO fund returns of limits to the taxdeductibility of LBO interest payments are likely to be modest, in part because a large portion of the value from expected tax savings is effectively paid for upfront by the private equity firm in the form of higher LBO purchase prices.Moreover, the authors do not expect to see LBO funds change their business model in response to this change in taxdeductibility. Based on their findings, the authors expect neither a significant decline in LBO leverage nor a notable change in the pricing of PE deals. As finance scholars have suggested, there are significant benefits associated with the use of debt that have nothing to do with the tax shield provided by the deductibility of interest. The authors' results provide yet another piece of evidence suggesting that taxes have at most a second‐order effect on corporate financing decisions—and that the gains to private equity come mainly from improvements in operating performance.

Firm-level determinants of capital structure decision – evidence from food &agro product companies in India

The purpose of this empirical study is to explore the factors which influence capital structure decision of the firms in the context of emerging market. Particularly, this study examines the impact of firms’ characteristics, on the capital structure of Indian food & agro product firms listed in NSE (National Stock Exchange) during the period 2007–2011, using panel data. Here firms'characteristics such as profitability, size, growth, tangibility, non-debt tax shields, liquidity, were used as independent variables, while leverage ratios, such as total debt ratio, long term debt ratio and short term debt ratio were the dependent variables. In order to find differences, if any, exists among the firms'life cycle stages, the sample firms are split into three, based on their age - old firms, middle firms and young firms. Fixed and random effect regression models are used to find the effect here. The results reveal that factors such as profitability, tangibility, non debt tax shield and liquidity have significant influences on at least one of the measures of leverage chosen by firms in the Indian context. Results of this study validate the prediction of the tradeoff model along with the pecking order theory and agency model of capital structure seems to provide partial explanations.

Does the Capital Structure Really Matter? A Study from the United Kingdom

Among other things, the study employs time series and cross-sectional regressions to shed some intuitive light on the relevance of the Modigliani and Miller (1958) irrelevance hypothesis. Based on the principal objective of the study, I attempt to empirically examine the relationships between explanatory variables: capital structure (gearing ratio), debt tax shields, non-debt tax shields, asset structure and bankruptcy probability and the dependent variable: firm value. Based on the analysis of a set of ten UK industries, my findings are not compatible with the Modigliani and Miller (1958) propositions. The evidence is highly consistent with the Modigliani and Miller (1963) theoretical predictions about tax benefits. Therefore, capital structure really matters if firms judiciously use corporate debt. The study also sheds some insightful light on the inter-industry capital structure differences. Using a one-way ANOVA test, I find that various industries, subject to various nature of business, have developed characteristically different capital structures. Another persuasive and interesting findings that I have uncovered through this study are that, costs of debt are similar across a set of industries studied regardless of the capital structure.

Impacts of Unconditional Conservatism on Debt Financing as a Non Debt Tax Shield

Impacts of Unconditional Conservatism on Debt Financing as a Non Debt Tax Shield

Nigeria Ailing Industries and the Capital Structure Theory: A Need for Concern

It is necessary to identify that what are factors contribute to the firms’ capital structure composition in its operation. Hence the present study was undertaken with the objective of finding out the relationship between capital structure determinants and ailing manufacturing firms of the listed companies in Nigeria. Using a multiple regression analysis, ailing manufacturing companies in Nigeria stock exchange market was examined for the period of 2005-2010. The final sample consists of 14 manufacturing companies. In this study, dependent variable that is, leverage level of the companies, is measured by long-term debt ratio, short term debt ratio and total debt ratio. Capital structure determinants (independent variables) are measured by capital intensity, tangibility, profitability, firm size and non- debt tax shield. Findings showed that the direction of the explanatory variables such as tangibility, profitability, firm size and non-debt tax shields with total debt largely consistent with the explanations of trade-off theory and prove past empirical findings also.

CoCos, Bail-In, and Tail Risk

Contingent convertibles (CoCos) and bail-in debt for banks have been proposed as potential mechanisms to enhance financial stability. They function by converting to equity when a bank approaches insolvency. We develop a capital structure model to analyze the incentives created by these forms of contingent capital. Our formulation includes firm-specific and market-wide tail risk in the form of two types of jumps and leads to a tractable jump-diffusion model of the firm’s income and asset value. The firm’s liabilities include insured deposits and senior and subordinated debt, as well as convertible debt. Our model combines endogenous default, debt rollover, and jumps; these features are essential in examining how changes in capital structure to include CoCos or bail-in debt change incentives for equity holders. We derive closed-form expressions to value the firm and its liabilities, and we use these to investigate how CoCos affect debt overhang, asset substitution, the firm’s ability to absorb losses, the sensitivity of equity holders to various types of risk, and how these properties interact with the firm’s debt maturity profile, the tax treatment of CoCo coupons, and the pricing of deposit insurance. We examine the effects of varying the two main design features of CoCos, the conversion trigger and the conversion ratio, and we compare the effects of CoCos with the effects of reduced bankruptcy costs through orderly resolution. Across a wide set of considerations, we find that CoCos generally have positive incentive effects when the conversion trigger is not set too low. The need to roll over debt, the debt tax shield, and tail risk in the firm’s income and asset value have particular impact on the effects of CoCos. We also identify a phenomenon of debt-induced collapse that occurs when a firm issues CoCos and then takes on excessive additional debt: the added debt burden can induce equity holders to raise their default barrier above the conversion trigger, effectively changing CoCos to junior straight debt; equity value experiences a sudden drop at the point at which this occurs. Finally, we calibrate the model to past data on the largest U.S. bank holding companies to see what impact CoCos might have had on the financial crisis. We use the calibration to gauge the increase in loss absorbing capacity and the reduction in debt overhang costs resulting from CoCos. We also time approximate conversion dates for high and low conversion triggers.

Tax Reforms and the Capital Structure of Banks

The paper studies the link between corporate income tax reforms and domestic bank entities' financing decisions. We use a dataset of corporate income tax (CIT) reforms and estimate the effect of tax rate changes on leverage, dividend policies and earnings management of banks using BankScope (Orbis) data. Our results suggest that taxation influences all three variables in the first three years after the reform. Leverage increases with the CIT rate. The reason is that the statutory CIT rate determines the value of the debt tax shield. A higher tax rate increases incentives to use debt finance when interest payments are deductible from the CIT base. Also, dividend pay-outs increase after an increase of CIT rates. This could indicate that banks actively manage their pay-out policies around tax reforms and adjust their capital structure with changes in dividends. Furthermore, banks increase loss loan reserves in anticipation of a tax rate cuts since losses become less valuable with lower CIT rates. In the context of the current regulatory reform in the financial sector which focuses strongly on improving equity ratios of banks, our results suggest that future tax policies should focus on eliminating the favorable treatment of debt in general and for banks in particular. The reason is that this distortion at least partly undermines the regulatory objectives of increasing (regulatory) capital.

Does Corporate Taxation Affect Cross-Country Firm Leverage?

We evaluate the relation between firm leverage and taxation of corporate income using a dataset of mostly unlisted European corporations, highly representative of medium-sized and large firms. We use a correlated random effect approach in order to take into account unobserved heterogeneity and to assess the contribution of cross-sectional variation of the regressors. We also apply quantile regressions to evaluate a possible differential impact of taxation on leverage across firms. Our results suggest that corporate income taxation is positively related to leverage and explains part of the cross-country variability, showing a stronger effect for less levered firms. In accordance with the theory of the debt tax shield, the relation between debt and taxation is stronger for highly profitable firms. These findings are robust to the inclusion of different measures of the financial development and characteristics of the legal system of the country where firms are located.

BALANCE SHEET EFFECT SEBAGAI PENENTU DETERMINAN STRUKTUR MODAL ENAM BURSA EFEK PADA NEGARA-NEGARA ASEAN

Balance sheet effect is due to the relationship between the external and internalfactors. The purpose of this study is to obtain the result: firm size, firm growth, financial risk, asset structure, non debt tax shield on capital structure; influence of internal factors, the influence of internal and external factors of the company’s capital structure. The research was conducted in countries of ASEAN6, namely Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam. Unit of analysis of this study is that corporations have huge capitalization in 2008 until 2011. Data analysis using regression method Simultaneous and panels. The results showed: the size of the company has a positive and significant impact on the capital structure for ASEAN6 countries; growth has a negative and significant impact on the capital structure in the country of Malaysia, the Philippines, and Thailand; financial risk has a negative and significant impact on the capital structure in Singapore , asset structure has a positive and significant impact on the capital structure for Singapore, Malaysia, and the Philippines; non-debt tax shield and a significant negative effect on the capital structure for the State of Indonesia and Malaysia, the interest rate has no significant effect on the capital structure in cASEAN 6 countries; foreign exchange rate has a positive and significant effect for the Philippines; rate of inflation on capital structure has a negative and significant impact to the state of Indonesia, the Philippines, and Vietnam while Malaysia, Thailand and Singapore have a positive and significant impact; economic growth on the capital structure has a negative and significant impact to the state of Indonesia, the Philippines, and Vietnam while Negara Malaysia, Thailand and Singapore have a positive and significant impact; contained internal influence on the capital structure for six ASEAN countries; There are internal and external influences on capital structure for ASEAN6 countries.

Looking into the Black Box of Firm Valuation: A Monte-Carlo Simulation Model for Assessing the Riskiness of Debt and Tax Savings

The paper suggests a practical approach to firm valuation based on probabilistic simulation methodology. We develop a model with risky debt and risky tax shield using risk-neutral technique. The model allows investigate dependencies immediately between probabilistic distributions of cash flows to unlevered and levered firm, debt, equity and tax savings. The model also gives a possibility to calculate values and implied time-varying costs of debt, equity, tax shield and levered firm.We consider the risks of cash flows to debt, equity and tax savings from the perspective of redistribution of cash flow to firm before taxes between shareholders, lenders and government. The finding is that interest expense on debt provides protection to both shareholders and lenders. This is because claims of lenders, government and shareholders are subordinated. Interest expense has priority before tax payments, principal payments and residual payments to owners. Therefore cash flow to firm before taxes is firstly used to repay interest payments, then income taxes, then principal payments, and only then forms cash available to owners. The value of tax benefits of lenders can be found by comparing the case of a firm with tax deductions of interest expense with the case of the firm without tax deduction of interest expense.Hence we differentiate between overall tax shield, tax shield of owners and tax shield of lenders. This differentiation is necessary for appropriate firm valuation. We also redefine the objective function of value based management. Financial literature states that the objective of the firm is to maximize the value of levered firm. Instead we show that the objective of the firm should be the maximization of value of levered firm after subtraction of tax shield of lenders. Firms are formed to produce benefits to owners. Owners are not interested in donating tax benefits to lenders. Owners should not seek for overall tax benefits, but instead owners pursue the objective of maximizing only tax benefits they receive.Monte-Carlo simulations discover that the dependence of value of tax benefits of shareholders on financial leverage has an inverted U-shaped form. This is because under high leverage the overall tax savings begin to redistribute mostly to lenders. This means that the optimal capital structure from the owners perspective is not when firm is all-debt financed as suggested by Miller (1988). Instead the maximum value of tax benefits of shareholders is reached much before the firm is financed entirely with debt. However firm value function is never-decreasing, as overall tax shield function cannot be decreasing.We suggest a practical approach to calculate value of debt, value of overall tax savings, value of tax savings of shareholders, value of tax savings of lenders and value of levered equity using data about systematic risk and probability distribution of cash flow to firm. The approach also provides estimates of cost of debt and cost of overall tax savings, as well as costs of tax savings of shareholders and lenders. We also show even for simple perpetuities with fixed absolute amount of contractual debt obligations cost of debt, cost of levered equity and costs of tax savings of different stakeholders do not remain constant as it is often assumed in financial literature, but instead change in time.