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Taxes and Capital Structure: Evidence from Firms' Response to the Tax Reform Act of 1986

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  • Givoly, Dan, et al

Abstract

While the theoretical relation between taxes and capital structure has been extensively analyzed, the empirical evidence on this issue has thus far been inconclusive. One of the main difficulties confronting previous empirical studies of the cross-sectional relationship between taxes and leverage was the control of intervening variables. The Tax Reform Act of 1986 (TRA), which drastically changed the tax regime, provides a unique opportunity to assess the interaction between taxes and leverage decisions in a controlled environment. The authors test the relationship between leverage and certain tax-related variables for a large sample of companies in the years surrounding the enactment of TRA. The results support the tax-based theories of capital structure. The findings indicate that there exists a substitution effect between debt and nondebt tax shields, and that both corporate and personal tax rates affect leverage decisions. Coauthors are Dan Givoly, Aharon R. Ofer, and Oded Sarig. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Givoly, Dan, et al, 1992. "Taxes and Capital Structure: Evidence from Firms' Response to the Tax Reform Act of 1986," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 331-355.
  • Handle: RePEc:oup:rfinst:v:5:y:1992:i:2:p:331-55
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