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Curbing corporate debt bias: Do limitations to interest deductibility work?

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  • De Mooij, Ruud
  • Hebous, Shafik

Abstract

Tax provisions favoring corporate debt over equity finance (“debt bias”) are widely recognized as a risk to financial stability. This paper explores whether and how thin-capitalization rules, which restrict interest deductibility beyond a certain amount, affect corporate debt ratios and mitigate corporate default risk. We find that rules targeted at related party borrowing (the majority of today's rules) have no significant impact on debt bias, as they do not affect third-party borrowing. These rules also have no effect on broader indicators of firm corporate distress. Rules applying to all debt, in contrast, turn out to be effective: the presence of such a rule reduces the debt-asset ratio in an average company by 5 percentage points; and they reduce the probability of a firm being in financial distress by 5 percent. Debt ratios are found to be more responsive to thin capitalization rules in industries characterized by a high share of tangible assets.

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  • De Mooij, Ruud & Hebous, Shafik, 2018. "Curbing corporate debt bias: Do limitations to interest deductibility work?," Journal of Banking & Finance, Elsevier, vol. 96(C), pages 368-378.
  • Handle: RePEc:eee:jbfina:v:96:y:2018:i:c:p:368-378
    DOI: 10.1016/j.jbankfin.2018.07.013
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    Cited by:

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    5. Ruud Mooij & Li Liu, 2020. "At a Cost: The Real Effects of Transfer Pricing Regulations," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 68(1), pages 268-306, March.
    6. Stephanie Guichard, 2017. "10 Years after the Global Financial Crisis: What Have We Learnt About International Capital Flows?," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 8(03), pages 1-30, October.
    7. Kalcheva, Ivalina & Plečnik, James M. & Tran, Hai & Turkiela, Jason, 2020. "(Un)intended consequences? The impact of the 2017 tax cuts and jobs act on shareholder wealth," Journal of Banking & Finance, Elsevier, vol. 118(C).
    8. Nicola Comincioli & Paolo M. Panteghini & Sergio Vergalli, 2021. "Welfare effects of business taxation under default risk," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 28(6), pages 1412-1429, December.
    9. Serena Fatica & Wouter Heynderickx & Andrea Pagano, 2020. "Banks, Debt And Risk: Assessing The Spillovers Of Corporate Taxes," Economic Inquiry, Western Economic Association International, vol. 58(2), pages 1023-1044, April.
    10. Yang, Zhenbing & Chen, Zhuo & Shi, Qi & Yan, Bing, 2021. "Does outward foreign direct investment increase debt ratio? Firm-level evidence from China," Structural Change and Economic Dynamics, Elsevier, vol. 57(C), pages 1-12.
    11. Masud Alam, 2021. "Heterogeneous Responses to the U.S. Narrative Tax Changes: Evidence from the U.S. States," Papers 2107.13678, arXiv.org.
    12. Lucio Masserini & Matilde Bini & Alessandro Zeli, 2021. "A Longitudinal Analysis of Riskiness Indicators After the 2008 and 2011 Economic Crises: The Case of Italian Manufacturing," Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Springer, vol. 156(2), pages 499-513, August.
    13. Diego Andrés Correa-Mejía & Mauricio Lopera-Castaño, 2020. "Financial ratios as a powerful instrument to predict insolvency; a study using boosting algorithms in Colombian firms," Estudios Gerenciales, Universidad Icesi, vol. 36(155), pages 229-238, June.

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    More about this item

    Keywords

    Corporate tax; Capital structure; Debt bias; Thin capitalization rule;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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