Eun Kang; Noronha, Gregory
September 2008
Review of Business Research;2008, Vol. 8 Issue 4, p72
Academic Journal
In this paper we examine the effect of tax on capital structure by analyzing the change in debt ratios around the 1986 Tax Reform Act (TRA). Consistent with tax-based theories of capital structure, which predict an increase in the value of the tax shield as the tax rate rises, debt ratios increase following the TRA, which -- even though it lowered the marginal corporate tax rate from 46% to 34% -- raised the effective rate by closing several loopholes. We also test one of the empirical implications of Maksimovic and Zechner (1991). They predict that firms with risky (low risk) projects decrease (increase) their debt levels as the corporate tax increases. We examine debt ratios and riskiness of firms within an industry before and after the TRA, and find some support for their prediction.


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