Equity-financed Investment Research Articles

Capital Gains Taxes and Real Corporate Investment: Evidence from Korea

This paper assesses the effects of capital gains taxes on investment in the Republic of Korea (hereafter, Korea), where capital gains tax rates vary at the firm level by firm size. Following a reform in 2014, firms with a tax cut increased investment by 34 log points and issued more equity by 9 cents per dollar of lagged revenue, relative to unaffected firms. Additionally, the effects were larger for firms that appeared more cash constrained or went public after the reform. Taken together, these findings are consistent with the “traditional view” predicting that lower payout taxes spur equity-financed investment by increasing marginal returns on investment. (JEL D25, G31, G32, H25, H32, L25)

The Taxation of Industrial Foundations in Sweden (1862–2018)

Abstract It has been argued that the Swedish tax system has favored firm control through industrial foundations, which should have inhibited entrepreneurship and economic growth. However, research has been hampered because of a lack of systematic historical tax data. The purpose of this study is to describe the evolution of tax rules for industrial foundations in Sweden between 1862 and 2018 and to calculate the marginal effective tax rate (METR) on capital income. The results show that the METR for an equity-financed investment is typically below 20% and occasionally peaks at approximately 40%. When the requirement that industrial foundations have to donate the bulk of capital income (less capital gains) for charitable purposes is treated as a tax, the METR is seldom below 50% when financing investments with new share issues and often exceeds 100%.

Is there a right time for corporate investment?

Purpose – The purpose of this paper is to determine whether corporate investment in real fixed assets in hot issue markets leads to higher income to shareholders than that in other equity market conditions. Design/methodology/approach – The authors address the research question in two steps: first, the authors identify how security issuances in hot and cold issue markets influence corporate investment decisions. Second, the authors examine how debt- and equity-financed investments in two different market conditions affect future holding period returns. The sample includes an unbalanced panel data set consisting of all non-financial and non-utility US companies from 1973 to 2006. The authors apply both firm- and industry-level fixed effect methods to estimate the coefficients of two separate empirical models. Findings – The authors find that equity issuances increase firms' capital investments in hot issue markets. These equity-financed investments in hot equity markets result in higher returns to shareholders compared to those in other market conditions. Therefore, there exists a window of opportunity for firms to issue new equities and make investments, which in turn improve shareholders' wealth. Practical implications – The findings convey a critical message to corporate managers about the right timing of equity-financed capital investments. Originality/value – While earlier research focuses on determining a specific equity market condition that favours new issuances, this paper determines a particular equity market condition when firms typically choose value-enhancing equity-backed projects for investment.

Internal Capital Market and Dividend Policies: Evidence From Business Groups

We argue that internal capital market imperatives of business groups i.e., reallocation of capital across group firms, influences an affiliated firm's dividend policy. Intuition is developed in a model in which business group insiders distribute dividends from cash-rich firms and use their share of payout to invest in other affiliated firms. Employing multi-country panel-data, we find support for this channel: Dividends by a group firm are positively related with equity-financed investments by its affiliated firms. Results are corroborated by exploiting variation in a firm's investment opportunity generated by changes in import tariff policy: a shock to investment opportunity of an affiliated firm is propagated to dividend policies of other firms in its group.

Optimal Investment and Financial Strategies under Tax-Rate Uncertainty

Abstract In this paper, we apply a real-option model to study the effects of tax-rate uncertainty on a firm’s decision. In doing so, we depart from the relevant literature, which focuses on fully equity-financed investment projects. By letting a representative firm borrow optimally, we show that debt finance not only encourages investment activities but can also substantially mitigate the effect of tax-rate uncertainty on investment timing.

Effects of a Flat Rate Tax on Investment Decisions and Capital Structure of Companies

Recently, there have been various proposals in Germany to exempt interest income of individuals from progressive income taxation, and to levy a flat source tax, instead. The isolated introduction of a flat tax on interest income would have a significant effect on all investment and financing decisions of investors in individual enterprises, partnerships and corporations. Any equity-financed investment subject to regular taxation would become relatively less attractive compared to interest income subject to the flat tax.This paper analyzes the possible impact of a flat rate tax on business decisions in the context of the German income and corporation tax (sections 2 and 3). Proposals for changes in corporate taxation are developed to avoid the undesired effects of a flat tax on financing decisions (section 4). In particular we show that this is possible without lowering the tax burden on corporate profits to the level of the flat rate tax.

Optimal Investment and Financial Strategies Under Tax Rate Uncertainty

In this paper we apply a real-option model to study the effects of tax rate uncertainty on a firm's decisions. In doing so, we depart from the relevant literature, which focuses on fully equity-financed investment project. By letting a representative firm borrow optimally, we show that debt finance not only encourages investment activities but can also substantially mitigate the effect of tax rate uncertainty on investment timing.

The Profitability and Equity Financing of Style Groups: 1906-2006

We extend the evidence of Fama and French (1995) on the post-1962 profitability and equity financing of firms in different style groups (small versus big, value versus growth) to 1926-2006. The emphasis is on whether equity-financed investment varies with cashflows and price-to-book ratios in ways that support or violate the pecking order model of Myers (1984) or the Q theory of investment. The long-term perspective from the results for 1926-2006 provides insights into inferences about the pecking order and Q theory drawn from previous work that focuses on shorter, more recent periods.

The Deduction of Interest Payments in an Ideal Tax on Realized Business Profits

For the most part, the need for capitalization in a realization system is well recognized by policy makers and tax analysts alike. The broad consensus breaks down, however, with respect to interest payments. Some tax analysts argue that interest is inherently a current expense and ought to be deductible currently except in rather special circumstances. This viewpoint apparently is widely accepted in accountancy. Whatever the views of tax analysts and accountants may be, the simple fact is that all countries imposing a tax on business profits fail to apply to interest payments the capitalization rules that are routinely applied to other types of rental payments. This permissive and special treatment of interest payments compromises the integrity of a tax on realized income and results in the substantial undertaxation of business profits around the world. Part I of this paper raises and offers answers to questions that go to the foundations of the income tax - indeed, to the foundations of any broad-based redistributive tax. In that part, I analyze the policy goals and basic features of an ideal or model tax on realized income. I conclude that an ideal realization tax has some significant practical advantages in taxing business income over either a Haig/Simons income tax or a Kaldor/Andrews consumption tax, whatever the relative merits of a realization tax may be in some utopian world of our imagination. In particular, I argue that a realization system is better able to deal with certain realities - valuation issues and cross-border issues - that alternative income and consumption tax systems do not deal with very well. I examine in Part II the proper treatment, in a tax on realized income, of interest costs incurred by a taxpayer engaged in business activities. In brief, I argue that interest costs should be treated in much the same way that other types of rental costs are treated. For example, interests costs incurred to acquire or produce inventory property should become part of the cost of goods sold and should not become deductible until the income from the sale of the related inventory property has been realized. In addition, interest payments traced to income that is not subject to current taxation because it has been earned through a foreign affiliate should not be deductible until the related income has been realized. A proper system for capitalizing interest payments would reduce substantially the bias in favor of debt-finance investments over equity-financed investments found in all income tax systems.

Do Business Groups Use Dividends to Fund Investments?

In this paper we offer a theory of dividends in business groups. We hypothesize that business groups operate a type of internal capital market and use dividends as a transparent means of transferring cash across group firms. The intuition, formalized in a simple model, is that insiders use their share of dividends to finance investment in member firms, thereby limiting the dilution of their equity stake when firms raise outside capital. The correlation between dividends and investments is predicted to be stronger for smaller and more profitable investments and when the legal regime is more protective of shareholder rights. We test our predictions using firm level data from 23 countries from Asia and Europe. Our evidence is consistent with the predictions. Changes in group firm dividends are positively associated with changes in both contemporaneous and subsequent equity-financed investments in other member firms. The association is stronger for smaller and more profitable investments and in firms located in countries with strong legal regimes. Aggregate dividends paid by group firms in a year finance upto 10% of insider equity investment in the next year. Consistent with our model, insider holding in group firms is positively related to dividend distribution from the other member firms.

Taxation and Corporate Payout Policy

This study examines the dividend trends of 590 Indian companies over the period 1992–2004 of all manufacturing, non-government, non-financial, and non-banking companies listed on BSE for which there was no missing financial information over the period of the study. Dividend payout has been chosen for the purpose of examining the impact of taxation on dividend policy. Analysis was done for the full period under consideration, immediate one year of tax regime change, and immediate three years of tax regime change so as to conclusively establish the results and also to note the variations in results over different time frames, if any. For the purpose of this study, the sample was classified on the basis of dividend history, industry, and size. Of the 590 companies, 240 companies were regular payers—the companies that had paid dividend regularly without ever skipping the payments throughout the period of the study. According to tax preference or trade-off theory, favourable dividend tax should lead to higher payouts. The Union Budget of 1997 made dividends taxable in the hands of the company paying them and not in the hands of the investors receiving them. The corporate dividend tax aimed at improving the economic growth and flexibility by eliminating the tax bias against equity-financed investments thereby promoting saving and investment. The new system aimed at reducing the tax bias against capital gains in the earlier tax system, encouraging investment, and enhancing the long-term growth potential of the Indian economy. As compared to the earlier tax regime where the recipient shareholder paid the tax on the dividend received primarily on the basis of marginal tax slab rate applicable to him/her (varying between 0% to 30%), in the current structure of corporate dividend tax, the dividend paying companies pay dividend tax at a flat rate of 12.5 per cent as of financial year 2005–06. Implicitly, the present corporate dividend tax regime can be termed as a more favourable tax policy. The analysis of influence of changes in the tax regime on dividend behaviour reveals the following: Trade-off or tax preference theory does appear to hold true in the Indian context in the case of both the total sample companies as well as the regular payers. While in the case of total sample companies, the results are significant for the entire period of study and the immediate three year period, in case of regular payer, the results are significant for all the three time periods analysed. Though the results are somewhat mixed, it can be largely inferred that there is a significant difference in average dividend payout ratio in the two different tax regimes. There are wide industry-wise and size-wise variations in empirical findings visible over the period of study.

Debt- and Equity-Financed Investment: Equilibrium Structure and Efficiency Implications

This paper considers the financing of investment in the presence of information asymmetry between insiders and outsiders of the firms. It establishes a well-defined capital structure for the economy as a whole with the following features: low-productivity firms rely on the equity market to finance investment at a relatively low level; mediumproductivity firms may not invest at all; and high-productivity firms rely on the debt market to finance investment at a relatively high level. It is shown that the debt market is efficient, with respect to the scope and the amount of investment made by each firm. However, the equity market fails: its scope is too narrow and the amount of investment each firm makes is too little. A unique but rather unconventional policy tool is proposed to achieve constrained Pareto-efficiency, i.e., subsidies to those firms that choose to equity-finance their investment (i.e., equity-market

Capital Flows with Debt- and Equity-Financed Investment: Equilibrium Structure and Efficiency Implications

This paper distinguishes between debt and equity flows in the presence of information asymmetry between the firm`s insiders and outsiders in a small open economy. It shows the inadequacy of capital investment because its scope is too narrow and the investment each firm makes is too little. An unconventional policy tool is proposed to correct the market failure: lump-sum subsidies to firms that choose to equity-finance their investments.

Taxation and the Cost of Capital in Hungary and Poland: A Comparison with Selected European Countries

The effective rates of taxation faced by a representative investor located in a major capital exporting country for investments in machinery and buildings in nine capital importing European countries are compared. Poland and Hungary are found to have relatively high effective tax rates on equity-financed investment. The analysis suggests that both countries would benefit from streamlining allowances for capital cost recovery and possibly lowering statutory corporate tax rates--as permitted by the revenue constraint--rather than providing tax preferences for foreign investors.

ON EFFECTIVE TAX RATES AND STEADY-STATE TAX REVENUES

Previous articleNext article No AccessNOTES AND COMMENTSON EFFECTIVE TAX RATES AND STEADY-STATE TAX REVENUESJOEL SLEMRODJOEL SLEMROD Search for more articles by this author PDFPDF PLUS Add to favoritesDownload CitationTrack CitationsPermissionsReprints Share onFacebookTwitterLinkedInRedditEmail SectionsMoreDetailsFiguresReferencesCited by National Tax Journal Volume 40, Number 1March 1987 Published for: The National Tax Association Article DOIhttps://doi.org/10.1086/NTJ41789683 Views: 1Total views on this site © 1987 National Tax Association. All rights reserved.PDF download Crossref reports no articles citing this article.