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Taxes, Leverage, and the Cost of Equity Capital

Journal of accounting research, 2006-09, Vol.44 (4), p.691-723 [Peer Reviewed Journal]

Copyright 2006 The Institute of Professional Accounting, University of Chicago ;University of Chicago on behalf of the Institute of Professional Accounting, 2006 ;ISSN: 0021-8456 ;EISSN: 1475-679X ;DOI: 10.1111/j.1475-679X.2006.00214.x ;CODEN: JACRBR

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  • Title:
    Taxes, Leverage, and the Cost of Equity Capital
  • Author: DHALIWAL, DAN ; HEITZMAN, SHANE ; ZHEN LI, OLIVER
  • Subjects: Accounting ; Business structures ; Capital costs ; Corporate finance ; Corporate income taxes ; Corporate taxes ; Cost of equity ; Dividends ; Equity ; Equity capital ; Estimated taxes ; Financial leverage ; Income taxes ; Personal debt ; Personal income taxes ; Risk premiums ; Tax rates ; Taxation
  • Is Part Of: Journal of accounting research, 2006-09, Vol.44 (4), p.691-723
  • Description: We examine the associations among leverage, corporate and investor level taxes, and the firm's implied cost of equity capital. Expanding on Modigliani and Miller [1958, 1963], the cost of equity capital can be expressed as a function of leverage and corporate and investor level taxes. Based on this expression, we predict that the cost of equity is increasing in leverage, and that corporate taxes mitigate this leverage-related risk premium, while the personal tax disadvantage of debt increases this premium. We empirically test these predictions using implied cost of equity estimates and proxies for the firm's corporate tax rate and the personal tax disadvantage of debt. Our results suggest that the equity risk premium associated with leverage is decreasing in the corporate tax benefit from debt. We find some evidence that the equity risk premium from leverage is increasing in the personal tax penalty associated with debt.
  • Publisher: Malden, USA: Blackwell Publishing Inc
  • Language: English
  • Identifier: ISSN: 0021-8456
    EISSN: 1475-679X
    DOI: 10.1111/j.1475-679X.2006.00214.x
    CODEN: JACRBR
  • Source: Alma/SFX Local Collection
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