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Capital structure puzzle: the interrelationship between leverage, taxes and other micro economic factors

  • Sinha, Pankaj
  • Bansal, Vishakha

The capital structure puzzle still remains unsolved. Every year there are many incidences of firms, reporting very high and risky levels of debt ratios. Since debt has tax advantages over other sources of capital, this paper employs simulated marginal tax rate (MTR) and its variants to study the tax effects on leverage ratios of profitable Indian companies. The paper analyses three different measures of leverage; debt to asset (DAR) ratio, incremental debt to total assets ratio (DINC) and debt to capital employed (DAR1) ratio. For each measure of leverage ratio, different specifications based on four variants of MTR have been considered. The results confirm significant tax effects on debt ratios of profitable Indian companies. It was found that DINC is highly autoregressive and independent variables considered in this paper explain around 55% of the variation in DAR1. The study suggests a new measure of retained earnings (ERTA).

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File URL: https://mpra.ub.uni-muenchen.de/49878/1/MPRA_paper_49878.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 49878.

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Date of creation: 30 Aug 2013
Date of revision: 17 Sep 2013
Handle: RePEc:pra:mprapa:49878
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  1. Ivo Welch, 2011. "Two Common Problems in Capital Structure Research: The Financial‐Debt‐To‐Asset Ratio and Issuing Activity Versus Leverage Changes," International Review of Finance, International Review of Finance Ltd., vol. 11(1), pages 1-17, 03.
  2. Sinha, Pankaj & Bansal, Vishakha, 2012. "Algorithm for calculating corporate marginal tax rate using Monte Carlo simulation," MPRA Paper 40811, University Library of Munich, Germany.
  3. Brennan, Michael J & Schwartz, Eduardo S, 1984. " Optimal Financial Policy and Firm Valuation," Journal of Finance, American Finance Association, vol. 39(3), pages 593-607, July.
  4. John R. Graham & Michael L. Lemmon & James S. Schallheim, 1998. "Debt, Leases, Taxes, and the Endogeneity of Corporate Tax Status," Journal of Finance, American Finance Association, vol. 53(1), pages 131-162, 02.
  5. Kane, Alex & Marcus, Alan J & McDonald, Robert L, 1984. " How Big Is the Tax Advantage to Debt?," Journal of Finance, American Finance Association, vol. 39(3), pages 841-53, July.
  6. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  7. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  8. Ruud A. de Mooij, 2011. "The Tax Elasticity of Corporate Debt; A Synthesis of Size and Variations," IMF Working Papers 11/95, International Monetary Fund.
  9. 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.
  10. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March.
  11. MacKie-Mason, Jeffrey K, 1990. " Do Taxes Affect Corporate Financing Decisions?," Journal of Finance, American Finance Association, vol. 45(5), pages 1471-93, December.
  12. Graham, John R., 1996. "Proxies for the corporate marginal tax rate," Journal of Financial Economics, Elsevier, vol. 42(2), pages 187-221, October.
  13. Pauline M. Shum, 1996. "Taxes and Corporate Debt Policy in Canada: An Empirical Investigation," Canadian Journal of Economics, Canadian Economics Association, vol. 29(3), pages 556-72, August.
  14. Michael J. Barclay & Clifford W. Smith & Ross L. Watts, 1995. "The Determinants Of Corporate Leverage And Dividend Policies," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 4-19.
  15. Saumitra Bhaduri, 2002. "Determinants of capital structure choice: a study of the Indian corporate sector," Applied Financial Economics, Taylor & Francis Journals, vol. 12(9), pages 655-665.
  16. Michele Bernasconi & Anna Marenzi & Laura Pagani, 2005. "Corporate Financing Decisions and Non-Debt Tax Shields: Evidence from Italian Experiences in the 1990s," International Tax and Public Finance, Springer, vol. 12(6), pages 741-773, November.
  17. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
  18. Graham, John R., 1996. "Debt and the marginal tax rate," Journal of Financial Economics, Elsevier, vol. 41(1), pages 41-73, May.
  19. Alan J. Auerbach, 1985. "Real Determinants of Corporate Leverage," NBER Chapters, in: Corporate Capital Structures in the United States, pages 301-324 National Bureau of Economic Research, Inc.
  20. John R. Graham & Michael L. Lemmon, 1998. "Measuring Corporate Tax Rates And Tax Incentives: A New Approach," Journal of Applied Corporate Finance, Morgan Stanley, vol. 11(1), pages 54-65.
  21. Julian Alworth & Giampaolo Arachi, 2001. "The Effect of Taxes on Corporate Financing Decisions: Evidence from a Panel of Italian Firms," International Tax and Public Finance, Springer, vol. 8(4), pages 353-376, August.
  22. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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