Value Of Tax Shields And Capital Structure

Corporate income tax is an important determinant of Capital Structure.Since Modigliani and Miller(1963)developed a capital structure model including corporate income tax factor,a series of academic literature have tried to uncover the "Capital Structure Puzzle" from tax perspective.However,capital structure research still does not have a satisfactory conclusion in recent half century."Capital structure puzzle"thus still attracts the most attention and focus of academics in corporate finance research.On study of tax and Capital Structure,the first empirical question that scholars need to answer is how corporate income tax rate affects capital structure.Due to measurement error of "real tax rate" as well as other interfering factors,research has not yet get unified conclusion,which urgently need scholars conduct more effective research from more effective scenarios.After demonstrate that tax do affect capital structure through value of tax shields,academia need to address another question that is why company is not of 100%liabilities in the real world.DeAngelo and Masulis(1980)proposed that there is "substitution effect"between "non-debt tax shields" and the debt-related tax shields from tax perspective,which can solve the problem to some extent.In subsequent empirical evidence,this assumption was further verified,particularly after Mackie-Mason(1990)which suggested "Tax Exhaustion Hypothesis" should be considered when scholars examine the relationship between non-debt tax shields and debt.However,the areas of academic achievement is still focus on "investment-related tax shields" study,which urgently need scholars to develop "non-debt tax shields" from other scope in order to reduce measurement errors of "non-debt tax shield" and improve the explanatory power of empirical capital structure model.Unlike Western countries,China is still in a transitional economic period.During past over thirty years of reform and opening up process,our taxation system and its changes provide unique opportunity to develop capital structure theory.Based on unification of two different tax act,taxable wage act and 150%deduction of R&D expenditure,we study the relationship between corporate income tax rate,the"non-debt tax shield" and capital structure.Our research could not only reveal the"capital structure puzzle" to a certain extent,but also develop "local" capital structure theory based on our unique institutional context.Firstly,based on China corporate income tax reform in 2008,we study the effect of exogenous change of corporate income tax rate on capital structure.Our results are robust because research based on tax reform can better control other disturbances.Apart from this,the country's 2008 corporate income tax reform not only made some corporates' tax rate increase,but also made other corporates' tax rate decrease,this also provides a unique opportunity to examine the relationship between tax rate and capital structure.Our empirical results suggest that:After the tax reform,firms with tax rate reduced during the tax reform significantly decrease the debt level,but firms with tax rate increased during the tax reform significantly raise the debt level;the closer the companies are to the "tax exhaustion state",the effect of tax rate change on capital structure is less significant.Further study based on ownership nature of ultimate controller suggests:Non-state-owned firms raise the debt level much more than state-owned firms in firms with tax rate increased during the tax reform(about 10%),and Non-state-owned firms decrease the debt level much more than state-owned firms in firms with tax rate reduced during the tax reform(about 4%).The results suggest that non-state-owned firms are more aggressive than state-owned firms.Above results suggest that corporate income tax rate do positively affect capital structure.This conclusion provides a basis to further study the relationship between non-debt tax shields and capital structure.To reveal the enterprise "Underleverage Puzzle",much prior research have provided evidence on the "substitution effect" of"investment-related tax shields" on capital structure.From the other two factors of production,this paper also provides evidence on the relationship between wage-related tax shields,non-debt tax shields from R&D expenditures and capital structure,which could enlarge the research range of "non-debt tax shields".The tests between wage-related tax shields and capital structure suggest that:wage-related tax shields could cause the company's effective tax rate decreased,thereby induce a decline in debt levels,consistent with "substitution effect".When the standard limit on taxable wages exogenously changes,the debt levels declined simultaneous,which is also consistent with the hypothesis.The closer the companies are to "tax exhaustion state",the "substitution effect" between wage-related tax shields and capital structure is more significant,and the more obviously the company reduce debt levels after the standard limit taxable salary increase.These findings support the "tax exhaustion hypothesis".Compared to the state-owned enterprises,the"substitution effect" between wage-related tax shields and capital structure is more significant,in addition to this,non-state-owned enterprises decrease capital structure to more extent when the standard deduction rise.The tests between non-debt tax shields from R&D expenditures and capital structure suggest that:non-debt tax shields from R&D expenditures could cause the company's effective tax rate decreased,thereby induce a decline in debt levels,consistent with "substitution effect".The closer the companies are to "tax exhaustion state",the "substitution effect" between non-debt tax shields from R&D expenditures and capital structure is more significant.These findings support the "tax exhaustion hypothesis".Compared to the state-owned enterprises,the "substitution effect"between non-debt tax shields from R&D expenditures and capital structure is more significant in non-state-owned enterprises.This find suggests that non-state-owned enterprises consider more in tax factors when making capital structure decision,which also indirectly suggest that non-state-owned enterprises are more tax aggressiveness than state-owned enterprises.The test results between corporate income tax rate and capital structure verify the applicability of west capital structure theory in China.These results not only are essential to develop China's tax and capital structure theory,but also contribute to the world academic literature by providing empirical evidence from China.In addition to this,the research on the relationship between wage-related tax shields,non-debt tax shields from R&D expenditures and capital structure enlarges the Western academic literature on "non-debt tax shield",improves the explanatory power of capital structure model,and also solvers the "Underleverage Puzzle" to some extent.In addition,the article also reveals differences effect of the nature of property rights on capital structure through tax factors.These findings not only reveal the channel of ownership nature on capital structure,but also make contribution to the development of "local" capital structure theory.