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The Effect of Taxes and Depreciation on Corporate Investment and Financial Leverage

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  • Dammon, Robert M
  • Senbet, Lemma W
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    Abstract

    This paper provides a theoretical analysis of the effect of corporate an d personal taxes on the firm's optimal investment and financing decis ions under uncertainty. The results indicate that, when investment is allowed to adjust optimally, increases in investment-related tax shi elds due to changes in the corporate tax code are not necessarily ass ociated with reductions in leverage at the individual firm level, con trary to existing capital structure theory. Cross sectionally, firms with higher investment-related tax shields need not have lower debt-r elated tax shields unless all firms have perfectly correlated pretax cash flows. The implications of the results for empirical analysis ar e also discussed. Copyright 1988 by American Finance Association.

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    Bibliographic Info

    Article provided by American Finance Association in its journal Journal of Finance.

    Volume (Year): 43 (1988)
    Issue (Month): 2 (June)
    Pages: 357-73

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    Handle: RePEc:bla:jfinan:v:43:y:1988:i:2:p:357-73

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    Cited by:
    1. Broll, Udo & Wong, Kit Pong, 2003. "Capital structure and the firm under uncertainty," Dresden Discussion Paper Series in Economics 20/03, Dresden University of Technology, Faculty of Business and Economics, Department of Economics.
    2. Childs, Paul D. & Mauer, David C. & Ott, Steven H., 2005. "Interactions of corporate financing and investment decisions: The effects of agency conflicts," Journal of Financial Economics, Elsevier, vol. 76(3), pages 667-690, June.
    3. Miquel Faig & Pauline Shum, 1997. "INVESTMENT IRREVERSIBILITY AND ENDOGENOUS FINANCING: An Evaluation of the Corporate Tax Effects," Working Papers faig-97-02, University of Toronto, Department of Economics.
    4. José López-Gracia & Francisco Sogorb-Mira, 2008. "Testing trade-off and pecking order theories financing SMEs," Small Business Economics, Springer, vol. 31(2), pages 117-136, August.
    5. Miquel Faig & Pauline Shum, 1996. "Irreversible Investment, Financing Choice and Asymmetric Corporate Taxes," Working Papers faig-96-01, University of Toronto, Department of Economics.
    6. Cristina Aybar-Arias & Alejandro Casino-Martínez & José López-Gracia, 2012. "On the adjustment speed of SMEs to their optimal capital structure," Small Business Economics, Springer, vol. 39(4), pages 977-996, November.
    7. Peter MacKay & Gordon M. Phillips, 2002. "Is There an Optimal Industry Financial Structure?," NBER Working Papers 9032, National Bureau of Economic Research, Inc.
    8. Chen, Jean J., 2004. "Determinants of capital structure of Chinese-listed companies," Journal of Business Research, Elsevier, vol. 57(12), pages 1341-1351, December.
    9. Francis, Bill & Hasan , Iftekhar & Sharma, Zenu, 2011. "Leverage and growth: effect of stock options," Research Discussion Papers 19/2011, Bank of Finland.
    10. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.
    11. Moyen, Nathalie, 2007. "How big is the debt overhang problem?," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 433-472, February.
    12. Aanderson, Michael H. & Prezas, Alexandors P., 1998. "The interaction of investment and financing decisions under moral hazard," International Review of Economics & Finance, Elsevier, vol. 7(4), pages 379-392.
    13. Carl Chiarella & Toan Pham & Ah Boon Sim & Madeleine Tan, 1991. "Determinants of Corporate Capital Structure: Australian Evidence," Working Paper Series 3, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    14. Kwang Soo Cheong, 1997. "Corporate Income Taxation and Signaling," Working Papers 199713, University of Hawaii at Manoa, Department of Economics.
    15. Chen, Xiangfeng & Cai, Gangshu (George), 2011. "Joint logistics and financial services by a 3PL firm," European Journal of Operational Research, Elsevier, vol. 214(3), pages 579-587, November.
    16. Singh, Kuljot & Hodder, James E., 2000. "Multinational capital structure and financial flexibility," Journal of International Money and Finance, Elsevier, vol. 19(6), pages 853-884, December.
    17. Richardson, Grant & Lanis, Roman & Leung, Sidney Chi-Moon, 2014. "Corporate tax aggressiveness, outside directors, and debt policy: An empirical analysis," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 107-121.
    18. Broll, Udo & Wong, Keith K.P., 2010. "The firm under uncertainty: capital structure and background risk," Dresden Discussion Paper Series in Economics 04/10, Dresden University of Technology, Faculty of Business and Economics, Department of Economics.

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