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Does corporate taxation affect cross-country firm leverage?

  • Antonio De Socio

    ()

    (Bank of Italy)

  • Valentina Nigro

    ()

    (Bank of Italy)

We evaluate the relation between firm leverage and taxation of corporate income using a dataset of mostly unlisted European corporations, highly representative of medium-sized and large firms. We use a correlated random effect approach in order to take into account unobserved heterogeneity and to assess the contribution of cross-sectional variation of the regressors. We also apply quantile regressions to evaluate a possible differential impact of taxation on leverage across firms. Our results suggest that corporate income taxation is positively related to leverage and explains part of the cross-country variability, showing a stronger effect for less levered firms. In accordance with the theory of the debt tax shield, the relation between debt and taxation is stronger for highly profitable firms. These findings are robust to the inclusion of different measures of the financial development and characteristics of the legal system of the country where firms are located.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 889.

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Date of creation: Nov 2012
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Handle: RePEc:bdi:wptemi:td_889_12
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