IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this book chapter or follow this series

Taxation, Corporate Capital Structure, and Financial Distress

In: Tax Policy and the Economy: Volume 4

  • Mark Gertler
  • R. Glenn Hubbard

Is corporate leverage excessive? Is the tax code distorting corporate capital structure decisions in a way that increases the possibility of an economic crisis owing to "financial instability"? Answering these kinds of questions first requires some precision in terminology. In this paper, we describe the cases for and against the trend toward high leverage, and evaluate the role played by taxation. While provision of proper incentives to managers may in part underlie the trend to the debt, high leverage may in practice be a blunt way to address the problem, and one which opens up the possibility for undue exposure to the risks of financial distress. Our story takes as given the kinds of managerial incentive problems deemed important by advocates of leverage. We maintain, however, that when a firm is subject to business-cycle risk as well as individual risk, a profit maximizing arrangement is not simple debt, but rather a contract with mixed debt and equity features. That is, the contract should index the principal obligation to aggregate and/or industry-level economic conditions. We argue that the tax system encourages corporations to absorb more business cycle risk than they would otherwise. It does so in two respects: First, it provides a relative subsidy to debt finance; second, it restricts debt for tax purposes from indexing the principal to common disturbances. At a deeper level, the issue hinges on the institutional aspects of debt renegotiation. If renegotiation were costless, then debt implicitly would have the equity features relevant for responding to business-cycle risk. However, because of the diffuse ownership pattern of much of the newly issued debt and also because of certain legal restrictions, renegotiation is likely to be a costly activity.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.nber.org/chapters/c11572.pdf
Download Restriction: no

as
in new window

This chapter was published in:
  • Lawrence H. Summers, 1990. "Tax Policy and the Economy: Volume 4," NBER Books, National Bureau of Economic Research, Inc, number summ90-1, October.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 11572.
    Handle: RePEc:nbr:nberch:11572
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.orgEmail:


    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Mark L. Gertler & R. Glenn Hubbard, 1988. "Financial Factors in Business Fluctuations," NBER Working Papers 2758, National Bureau of Economic Research, Inc.
    2. Bernanke, Ben & Gertler, Mark, 1990. "Financial Fragility and Economic Performance," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 87-114, February.
    3. Ben S. Bernanke & John Y. Campbell, 1988. "Is There a Corporate Debt Crisis?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 83-140.
    4. Benjamin M. Friedman, 1986. "Increasing indebtedness and financial stability in the United States," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 27-61.
    5. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    6. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking Relationships," NBER Working Papers 3079, National Bureau of Economic Research, Inc.
    7. David M. Cutler & Lawrence H. Summers, 1987. "The Costs of Conflict Resolution and Financial Distress: Evidence from the Texaco-Pennzoil Litigation," NBER Working Papers 2418, National Bureau of Economic Research, Inc.
    8. Poterba, J.M., 1989. "Tax Reform And The Market For Tax-Exempt Debt," Working papers 514, Massachusetts Institute of Technology (MIT), Department of Economics.
    9. Altshuler, Rosanne & Auerbach, Alan J, 1990. "The Significance of Tax Law Asymmetries: An Empirical Investigation," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 61-86, February.
    10. Jeffrey K. MacKie-Mason, 1990. "Do Firms Care Who Provides Their Financing?," NBER Chapters, in: Asymmetric Information, Corporate Finance, and Investment, pages 63-104 National Bureau of Economic Research, Inc.
    11. Michael C. Jensen, 1989. "Active Investors, LBOs, and the Privatization of Bankruptcy," Journal of Applied Corporate Finance, Morgan Stanley, vol. 2(1), pages 35-44.
    12. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Bank monitoring and investment: evidence from the changing structure of Japanese corporate banking relations," Finance and Economics Discussion Series 86, Board of Governors of the Federal Reserve System (U.S.).
    13. John B. Shoven, 1987. "The Tax Consequences of Share Repurchases and Other Non-Dividend Cash Payments to Equity Owners," NBER Chapters, in: Tax Policy and the Economy, Volume 1, pages 29-54 National Bureau of Economic Research, Inc.
    14. Henry Kaufman, 1986. "Debt: the threat to economic and financial stability," Economic Review, Federal Reserve Bank of Kansas City, issue Dec, pages 3-11.
    15. Sanford Grossman & Oliver Hart, . "Corporate Financial Structure and Managerial Incentives," Rodney L. White Center for Financial Research Working Papers 21-79, Wharton School Rodney L. White Center for Financial Research.
    16. Jensen, Michael C, 1988. "Takeovers: Their Causes and Consequences," Journal of Economic Perspectives, American Economic Association, vol. 2(1), pages 21-48, Winter.
    17. Cooper, Russell & John, Andrew, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 441-63, August.
    18. Henry Kaufman, 1986. "Debt: the threat to economic and financial stability," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 15-26.
    19. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    20. Shleifer, Andrei & Vishny, Robert W, 1988. "Value Maximization and the Acquisition Process," Journal of Economic Perspectives, American Economic Association, vol. 2(1), pages 7-20, Winter.
    21. Lawrence H. Summers, 1989. "Taxation and Corporate Debt," Journal of Applied Corporate Finance, Morgan Stanley, vol. 2(1), pages 45-51.
    22. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:nbr:nberch:11572. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.