Banks, firms and the relative pricing of tax-exempt and taxable bonds

Risk and the miller equilibrium: Capital structure choice with risk-averse investors

“…Empirical testing concentrates on leverage irrelevancy, financial leverage clienteles, and the implied tax rate on bond income to the marginal bondholder (for examples of some of the initial research, see Kim, Lewellen, and McConnnell (1979), Skelton (1983), and Sarig and Scott (1985)). …”

Do tax‐exempt yields adjust slowly to substantial changes in taxable yields?

“…Wu, Wang, and Zhang (2006) showed that municipal bond yields are strongly affected by liquidity and default risk, and found that after controlling for these risks, the implied marginal tax rates are very close to the statutory tax rates of high-income individuals and corporations. McCue and Stevens (1992), and Skelton (1983) argued that yield differentials are consistent with market segmentation in the municipal market. Before 1986, banks were allowed to deduct the interest on funds used to purchase tax-exempts.…”

“…researchers found that the marginal tax rate implied by the spread between tax-exempt and taxable yields decreases with maturity (see Ang, Peterson, & Peterson, 1985;Green, 1993;Kryzanowski, Xu, & Zhang, 1995;Skelton, 1983). In addition, the municipal yield curve almost always has a positive slope (even when the taxable yield curve is inverted), and generally has a steeper slope than the taxable yield curve.…”

Expected Future Tax Policy and Tax-Exempt Bond Yields

“…The first model was developed by Eugene Fama (197T) and has subsequently received favorable empirical support from Skelton (1983). Fama noted that one class of investors, commercial banks, can operate simultaneously in both the taxable and tax exempt bond markets.…”

“…The role of banks in performing taxarbitrage with long-term bonds is more doubtful, and may be restricted by institutional limitations and other factors. Skelton (1983) notes that ...banks may deduct the interest payments on debt obligations incurred in the normal course of business while receiving tax-exempt coupon payments. ...however, liabilities with maturities in excess of three years are considered to be potential contributions to capital and as such are subject to scrutiny of the tax authorities.…”