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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.

Suggested Citation

  • Alan J. Auerbach, 1982. "Taxes, Firm Financial Policy and the Cost of Capital: An Empirical Analysis," NBER Working Papers 0955, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0955
    Note: PE

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    1. 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.
    2. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    3. 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.
    4. 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.
    5. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    6. 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 345-355, November.
    7. J. S. S. Edwards & M. J. Keen, 1984. "Wealth Maximization and the Cost of Capital: A Comment," The Quarterly Journal of Economics, Oxford University Press, vol. 99(1), pages 211-214.
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    Cited by:

    1. Strulik, Holger, 2003. "Capital tax reform, corporate finance, and economic growth and welfare," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 595-615, December.
    2. Czarnitzki, Dirk & Kraft, Kornelius, 2009. "Capital control, debt financing and innovative activity," Journal of Economic Behavior & Organization, Elsevier, vol. 71(2), pages 372-383, August.
    3. Auerbach, Alan J., 2002. "Taxation and corporate financial policy," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 19, pages 1251-1292 Elsevier.
    4. Fullerton, Don & Henderson, Yolanda Kodrzycki, 1989. "A Disaggregate Equilibrium Model of the Tax Distortions among Assets, Sectors, and Industries," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(2), pages 391-413, May.
    5. Lindhe, Tobias, 2002. "Methods of Mitigating Double Taxation," Working Paper Series 2002:8, Uppsala University, Department of Economics.
    6. Bronwyn Hall, 2004. "The financing of research and development," Chapters,in: Financial Systems, Corporate Investment in Innovation, and Venture Capital, chapter 2 Edward Elgar Publishing.
    7. Bronwyn H. Hall, 1992. "Investment and Research and Development at the Firm Level: Does the Source of Financing Matter?," NBER Working Papers 4096, National Bureau of Economic Research, Inc.
    8. Lindhe, Tobias, 2001. "Mitigating Double Taxation in an Open Economy," Working Paper Series 2001:5, Uppsala University, Department of Economics.
    9. Martin Feldstein, 1982. "The Fiscal Framework of Monetary Policy," NBER Working Papers 0966, National Bureau of Economic Research, Inc.
    10. Guenther, David A. & Sansing, Richard, 2006. "Fundamentals of shareholder tax capitalization," Journal of Accounting and Economics, Elsevier, vol. 42(3), pages 371-383, December.
    11. Bronwyn Hall, 1992. "R&D Tax Policy During the Eighties: Success or Failure?," NBER Working Papers 4240, National Bureau of Economic Research, Inc.
    12. Robert L. McDonald & Naomi Soderstrom, 1986. "Dividend and Share Changes: Is There a Financing Hierarchy?," NBER Working Papers 2029, National Bureau of Economic Research, Inc.
    13. Don Fullerton & Yolanda Henderson, 1987. "The Impact of Fundamental Tax Reform on the Allocation of Resources," NBER Chapters,in: Taxes and Capital Formation, pages 101-104 National Bureau of Economic Research, Inc.
    14. Leonardo Rhenals Rojas, 2005. "Costo de Uso del Capital en Colombia:1997 -2003," Macroeconomics 0502003, EconWPA.
    15. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
    16. Hall, Bronwyn H. & Lerner, Josh, 2010. "The Financing of R&D and Innovation," Handbook of the Economics of Innovation, Elsevier.
    17. R. Glenn Hubbard & Peter C. Reiss, 1989. "Corporate Payouts and the Tax Price of Corporate Retentions: Evidence from the Undistributed Profits Tax of 1936-1938," NBER Working Papers 3111, National Bureau of Economic Research, Inc.
    18. Asada, Toichiro & Semmler, Willi, 1995. "Growth and finance: An intertemporal model," Journal of Macroeconomics, Elsevier, vol. 17(4), pages 623-649.
    19. Fullerton, Don & Mackie, James B. III, 1989. "Economic Efficiency in Recent Tax Reform History: Policy Reversals or Consistent Improvements?," National Tax Journal, National Tax Association, vol. 42(1), pages 1-13, March.
    20. Bronwyn H. Hall, 1993. "R&D Tax Policy During the 1980s: Success or Failure?," NBER Chapters,in: Tax Policy and the Economy, Volume 7, pages 1-36 National Bureau of Economic Research, Inc.
    21. Holger Strulik, 2003. "Supply-Side Economics of Germany's Year 2000 Tax Reform: A Quantitative Assessment," German Economic Review, Verein für Socialpolitik, vol. 4(2), pages 183-202, May.

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