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Collateral, Taxes, and Leverage

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Listed:
  • Shaojin Li
  • Toni M. Whited
  • Yufeng Wu

Abstract

We quantify the importance of collateral versus taxes for firms' capital structures. We estimate a dynamic model in which a taxable firm seeks financing for investment, and a dynamic contracting environment motivates endogenous collateral constraints. Optimal leverage stays a safe distance from the constraint, balancing the tax benefit of debt with the cost of lost financial flexibility. We estimate this flexibility cost to be 7.2% of firm assets, a percentage that is comparable to the tax benefit. Models with different tax rates fit the data equally well, and leverage responds to the tax rate only when taxes are low.

Suggested Citation

  • Shaojin Li & Toni M. Whited & Yufeng Wu, 2016. "Collateral, Taxes, and Leverage," The Review of Financial Studies, Society for Financial Studies, vol. 29(6), pages 1453-1500.
    • Handle: RePEc:oup:rfinst:v:29:y:2016:i:6:p:1453-1500.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhw008
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