Corporate taxation and financial strategies under asymmetric information

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. In this article we study the corporate tax effects on credit market equilibria. In particular, we develop a model that accounts for five pieces of evidence: i) the existence of a tax incentive to borrow, ii) the negative relationship between leverage and profitability, iii) the existence of asymmetric information in credit markets, iv) the screening activity of lenders and v) the business cycle effects on the spread between the high-yield and the investment-grade interest rates on corporate loans. Assuming the existence of two types of firms, we show that either a separating or a pooling credit market equilibrium can arise. More importantly, the equilibrium is crucially affected by corporate taxation. Given these results, we also provide a welfare analysis and discuss corporate tax policy implications. Terms of use: Documents inJEL-Code: H200, D820.

Business Tax Policy under Default Risk

“…If therefore a policy-maker can affect systemic risk, it is useful to study the effects of volatility on a firm's value as well as on welfare. 5 As will be shown, welfare and tax revenue crucially depend on tax rates as well as on volatility and the expected cost of default. 6 In particular, welfare is decreasing in the tax rate under default risk.…”

“…For this reason, he proposes a Pigouvian tax, aimed at offsetting negative externalities arising from financial instability.2 For simplicity, we assume symmetric information and full interest deductibility. For a detailed analysis on business taxation under asymmetric information, seeCohen et al (2016) and the articles cited therein. Partial interest deductibility is left for future research.3 In this article we focus on the tax rate effects.…”

“…Barriers to restructuring have also declined in 10 countries, while reform activity affecting the personal costs to failed entrepreneurs has been less ambitious, with only Chile, Greece and Spain undertaking reforms since 2010". Of course, heterogeneous rules can lead to heterogeneous default costs 5. Here, we deal with one policy-maker who can implement both monetary and fiscal policies, although we are aware that separate entities deal with them.…”

Business Tax Policy Under Default Risk

“…If therefore a policy-maker can affect systemic risk, it is useful to study the effects of volatility on a firm's value as well as on welfare. 5 As will be shown, welfare and tax revenue crucially depend on tax rates as well as on volatility and the expected cost of default. 6 In particular, welfare is decreasing in the tax rate under default risk.…”

“…For this reason, he proposes a Pigouvian tax, aimed at offsetting negative externalities arising from financial instability.2 For simplicity, we assume symmetric information and full interest deductibility. For a detailed analysis on business taxation under asymmetric information, seeCohen et al (2016) and the articles cited therein. Partial interest deductibility is left for future research 3.…”