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Taxes, Firm Financial Policy and the Cost of Capital: An Empirical Analysis

  • Alan J. Auerbach

This paper develops a theoretical model of firm behavior consistent with the maximization of shareholder utility, and derives empirically testable implications of different theories of equity finance. Using data on firm earnings and previous investment and financial behavior, we assess whether firms treat new share issues as a more expensive source of finance than retentions, and whether such behavior varies across firms according to the composition of their shareholders. Our results strongly support the hypothesis that firms perceive a higher cost of capital when issuing new shares, and that the cost of capital varies significantly across firms having different estimated tax clienteles, as theory would predict.

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File URL: http://www.nber.org/papers/w0955.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0955.

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Date of creation: Aug 1982
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Publication status: published as Auerbach, Alan J. "Taxes, Firm Financial Policy and the Cost of Capital: An Empirical Analysis." Journal of Public Economics, Vol. 23, No. 1/2, (February/March 1984), pp. 27-57.
Handle: RePEc:nbr:nberwo:0955
Note: PE
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  1. Baumol, William J, et al, 1970. "Earnings Retention, New Capital and the Growth of the Firm," The Review of Economics and Statistics, MIT Press, vol. 52(4), pages 345-55, November.
  2. Edwards, J S S & Keen, M J, 1984. "Wealth Maximization and the Cost of Capital: A Comment," The Quarterly Journal of Economics, MIT Press, vol. 99(1), pages 211-14, February.
  3. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January.
  4. Michael Salinger & Lawrence H. Summers, 1983. "Tax Reform and Corporate Investment: A Microeconometric Simulation Study," NBER Chapters, in: Behavioral Simulation Methods in Tax Policy Analysis, pages 247-288 National Bureau of Economic Research, Inc.
  5. Elton, Edwin J & Gruber, Martin J, 1970. "Marginal Stockholder Tax Rates and the Clientele Effect," The Review of Economics and Statistics, MIT Press, vol. 52(1), pages 68-74, February.
  6. DeAngelo, Harry & Masulis, Ronald W., 1980. "Optimal capital structure under corporate and personal taxation," Journal of Financial Economics, Elsevier, vol. 8(1), pages 3-29, March.
  7. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
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