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The Effect of Business Risk on Corporate Capital Structure: Theory and Evidence

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  • Kale, Jayant R
  • Noe, Thomas H
  • Ramirez, Gabriel G

Abstract

Under corporate and personal taxation, the authors demonstrate that the relation between optimal debt level and business risk is roughly U-shaped. This result follows from the fact that the tax liability is an option portfolio that is long in the corporate tax option and short in the personal tax option. Therefore, the net effect of a change in business risk on the optimal debt level depends upon the relative magnitudes of the resultant marginal changes in the values of these two options. Results of empirical tests offer support for the predicted U-shaped relationship. Copyright 1991 by American Finance Association.

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Bibliographic Info

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

Volume (Year): 46 (1991)
Issue (Month): 5 (December)
Pages: 1693-715

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Handle: RePEc:bla:jfinan:v:46:y:1991:i:5:p:1693-715

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Cited by:
  1. Julian Alworth & Giampaolo Arachi, 2001. "The Effect of Taxes on Corporate Financing Decisions: Evidence from a Panel of Italian Firms," International Tax and Public Finance, Springer, vol. 8(4), pages 353-376, August.
  2. Mustafa Caglayan & Abdul Rashid, 2013. "The Response of Firms' Leverage to Risk: Evidence from UK Public versus Non-Public ManufacturingFirms," CFI Discussion Papers 1302, Centre for Finance and Investment, Heriot Watt University.
  3. Lutz Hahnenstein & Klaus Röder, 2007. "Who hedges more when leverage is endogenous? A testable theory of corporate risk management under general distributional conditions," Review of Quantitative Finance and Accounting, Springer, vol. 28(4), pages 353-391, May.
  4. Majumdar, Raju, 2012. "The role of secured debt in resolving agency conflicts and problems of asymmetric information: Indian evidence," MPRA Paper 37925, University Library of Munich, Germany.
  5. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September.
  6. Albert Banal-Estañol & Marco Ottaviani & Andrew Winton, 2013. "The Flip Side of Financial Synergies: Coinsurance versus Risk Contamination," Working Papers 484, Barcelona Graduate School of Economics.
  7. Bartholdy, Jan & Mateus, Cesário, 2006. "Debt and Taxes: Evidence from bank-financed unlisted firms," Finance Research Group Working Papers F-2006-02, University of Aarhus, Aarhus School of Business, Department of Business Studies.
  8. Vijay Jog & Jianmin Tang, 2001. "Tax Reforms, Debt Shifting and Tax Revenues: Multinational Corporations in Canada," International Tax and Public Finance, Springer, vol. 8(1), pages 5-25, January.
  9. Kale, Jayant R. & Shahrur, Husayn, 2007. "Corporate capital structure and the characteristics of suppliers and customers," Journal of Financial Economics, Elsevier, vol. 83(2), pages 321-365, February.
  10. Graham, John R., 1996. "Debt and the marginal tax rate," Journal of Financial Economics, Elsevier, vol. 41(1), pages 41-73, May.
  11. Rosellon Cifuentes, M.A., 1999. "Liquidation Values, Risk and Capital Structure," Discussion Paper 1999-32, Tilburg University, Center for Economic Research.
  12. Evaldo Guimarães Barbosa & Cristiana De Castro Moraes, 2003. "Determinants Of The Firm’S Capital Structure - The Case Of The Very Small Enterprises," Finance 0302001, EconWPA, revised 14 Feb 2003.
  13. Noronha, Gregory M. & Shome, Dilip K. & Morgan, George E., 1996. "The monitoring rationale for dividends and the interaction of capital structure and dividend decisions," Journal of Banking & Finance, Elsevier, vol. 20(3), pages 439-454, April.
  14. Hatzinikolaou, Dimitris & Katsimbris, George M. & Noulas, Athanasios G., 2002. "Inflation uncertainty and capital structure: Evidence from a pooled sample of the Dow-Jones industrial firms," International Review of Economics & Finance, Elsevier, vol. 11(1), pages 45-55, April.
  15. Geoffrey Shuetrim & Philip Lowe & Steve Morling, 1993. "The Determinants of Corporate Leverage: A Panel Data Analysis," RBA Research Discussion Papers rdp9313, Reserve Bank of Australia.
  16. Lord, Richard A. & McIntyre, James Jr., 2003. "Leverage, imports, profitability, exchange rates, and capital investment: a panel data study of the textile and apparel industries 1974-1987," International Review of Financial Analysis, Elsevier, vol. 12(3), pages 287-310.
  17. Ryen, Glen T. & Vasconcellos, Geraldo M. & Kish, Richard J., 1997. "Capital structure decisions: What have we learned?," Business Horizons, Elsevier, vol. 40(5), pages 41-50.
  18. Chhapra, Imran Umer & Asim, Muhammad, 2012. "Determinants of capital structuring: an empirical study of growth and financing behavior of firms of textile sector in Pakistan," MPRA Paper 51068, University Library of Munich, Germany.
  19. Rashid, Abdul, 2013. "Risks and financing decisions in the energy sector: An empirical investigation using firm-level data," Energy Policy, Elsevier, vol. 59(C), pages 792-799.

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