Changes in Corporate Capital Structures: Evidence from the 1986 Tax Reform Act

Abstract

This paper employs choice‐theoretic models to study the impact of the 1986 Tax Reform Act on firms' issue behavior and the determinants of corporate capital structures. Choice‐theoretic models allow researchers to examine firms' leverage decisions at the margin. Both parametric and semi‐parametric estimations are employed to perform a more precise statistical inference. The results show that firms tend to issue more debt after the 1986 Tax Reform Act. The results also support the theories based on the trade‐off between tax shields and financial distress costs, corporate non‐debt tax shields, and agency costs inclusive of those from free cash flows.