Collateral, Taxes, and Leverage

Shaojin Li; Toni M. Whited; Yufeng Wu

doi:10.1093/rfs/hhw008

Collateral, Taxes, and Leverage

Shaojin Li, Toni M. Whited, Yufeng Wu

Research output: Contribution to journal › Article › peer-review

Abstract

We quantify the importance of collateral versus taxes for firms' capital structures. We estimate a dynamic model in which a taxable firm seeks financing for investment, and a dynamic contracting environment motivates endogenous collateral constraints. Optimal leverage stays a safe distance from the constraint, balancing the tax benefit of debt with the cost of lost financial flexibility. We estimate this flexibility cost to be 7.2% of firm assets, a percentage that is comparable to the tax benefit. Models with different tax rates fit the data equally well, and leverage responds to the tax rate only when taxes are low.

Original language	English (US)
Pages (from-to)	1453-1500
Number of pages	48
Journal	Review of Financial Studies
Volume	29
Issue number	6
DOIs	https://doi.org/10.1093/rfs/hhw008
State	Published - Jun 18 2016

ASJC Scopus subject areas

Accounting
Finance
Economics and Econometrics

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10.1093/rfs/hhw008

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title = "Collateral, Taxes, and Leverage",

abstract = "We quantify the importance of collateral versus taxes for firms' capital structures. We estimate a dynamic model in which a taxable firm seeks financing for investment, and a dynamic contracting environment motivates endogenous collateral constraints. Optimal leverage stays a safe distance from the constraint, balancing the tax benefit of debt with the cost of lost financial flexibility. We estimate this flexibility cost to be 7.2% of firm assets, a percentage that is comparable to the tax benefit. Models with different tax rates fit the data equally well, and leverage responds to the tax rate only when taxes are low.",

author = "Shaojin Li and Whited, {Toni M.} and Yufeng Wu",

note = "Funding Information: This work used the Extreme Science and Engineering Discovery Environment (XSEDE), which is supported by National Science Foundation grant number ACI-1053575. Shaojin Li acknowledges support from NSFC Project 71303146. Xu Tian provided excellent research assistance. We thank two anonymous referees, Itay Goldstein (editor), Harry DeAngelo, Shane Heitzman, Erwan Morellec, Adriano Rampini, Neng Wang, and seminar participants at Cass Business School, CEMFI, Duke, EPFL, Indiana, Michigan, Northeastern, Princeton, urdue, Warwick, Wirtschaftsuniversit?t Wien, and York University for helpful comments and suggestions.",

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