| Construction period interest incurred after 1986 must be capitalized on firm-constructed real property and depreciated along with the asset over 27.5 or 31.5 years. Current deductibility of the interest, the customary treatment, changed to 10 year amortization in 1982. Each change increased the after-tax cost of debt for the company constructing its own assets. Did affected firms adapt by lowering their use of debt? Did the market discount their share prices in anticipation of the increased after-tax cost of debt?.; In a matched pairs sample, the difference in use of debt by firms that frequently and rarely capitalized interest decreased significantly from 1980 to 1989. The frequent firms used significantly more debt than the rare firms before 1987, but an equivalent amount after 1986. The Wilcoxon matched pairs signed ranks test revealed the relative use of debt and the Cox and Stuart test for trend established the significance of its downward pattern. These results confirm findings of an inverse relationship between debt use and the cost of debt (DeAngelo & Masulis, 1980).; Examination of share price behavior in eight months of interest capitalization legislation activity revealed no significant reaction by the firms that frequently capitalized interest, not even when sorted into high and low debt to equity ratio groups. Unexpectedly, a significant positive market reaction occurred for the rare firms. Concurrent tax law changes or other unidentified factors were, apparently, perceived favorably by shareholders of the rare firms.; This study evaluates a tax law change; affected firms did not change their use of debt, thus the Congressional objective of raising revenue was met. This study examines capital structure behavior after a tax law change when the tax advantage of debt differs among firms: a gap identified by Marsh (1982). This study tests for a market reaction during a tax law change; event studies of the release of SFAS #34, "Capitalization of Interest Cost," have been done (McDonald, Morris & Nichols, 1985; Hughes & Ricks, 1986), but none surrounding the interest capitalization tax law changes have been located. |
