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Corporate Leverage and Nondebt Tax Shields: Evidence on Crowding‐Out
Author(s) -
Downs Thomas W.
Publication year - 1993
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.1993.tb01362.x
Subject(s) - monetary economics , tax shield , economics , depreciation (economics) , leverage (statistics) , crowding out , capital structure , deferred tax , debt , cash flow , corporate tax , tax credit , tax reform , business , state income tax , finance , microeconomics , tax avoidance , public economics , profit (economics) , capital formation , financial capital , gross income , machine learning , computer science
A negative relationship between corporate leverage and tax shields has been predicted because a large nondebt tax shield reduces the expected value of interest tax savings and lessens the advantage of debt financing. Previous studies, however, have provided inconclusive and contradictory evidence on whether nondebt tax shields crowd‐out debt financing. The analysis herein relies on unique constructs of discounted depreciation tax shields and presents evidence that crowding‐out does not occur. Furthermore, it is shown that contradictory inferences may result from analysis of annual tax depreciation deductions instead of discounted tax shields. The findings suggest that firms with substantial cash flow from depreciation exploit their higher debt capacity by maintaining a capital structure with significantly more debt than otherwise.