Research On Tax Effect In Financing Decision Of Chinese Corporations

An enterprise, from its birth to growth, could not live without the support of sufficient funds. For an enterprise, funds are like blood for human body. It ensures an enterprise’s sustainable development. No matter how big the enterprise is and how efficiency the enterprise’s operation is, the desire for sufficient funds is the same for every enterprise. Hence, how to raise funds becomes a very realistic problem for an enterprise’s decision-maker. Raising funds is the most crucial part of an enterprise’s financial operation. It not only ensures an enterprise’s sustainable operation but affects the governance structure and operational efficiency as well.With the continuous development of China’s economic system reform, corporate financing model has been transformed gradually from a single financial injection, bank lending model into a modern, diversified market direct financing model. Changes in the pattern of financing as well as broaden of a wide range of financing channels require an enterprise to weigh the pros and cons in order to make rational decisions. There are many factors that affect corporate financing decisions, including not only the enterprise’s own internal factors but also external factors. Among the external factors, taxation is a very important aspect. Taxation is prevalent as an important source of state revenue. State exercises its functions based on tax revenue, tax is an important tool to obtain financial income. Based on the above rational, tax is inevitable as long as the state exists. Tax is a vital link between the state and enterprises, and it is also a crucial way for the state to monitor enterprise. Hence, when an enterprise is in the process of making a financing decision, tax should be taken into account as a major external factor.The reason why tax is able to have an impact on enterprise’s financing decisions is due to that tax is non-neutral. From the aspect of corporate income tax, regarding the interest originated through debt financing, the costs incurred can be deducted before the payment of corporate income tax. Hence, relatively speaking, companies without debt financing need to pay less income and then enjoy tax benefits. Relative to debt financing, when enterprise is using equity financing, the dividend can only be issued to shareholders after the payment of corporate income tax. As a result, businesses cannot get tax benefits. From this perspective, the cost of corporate debt financing is lower than the cost of the equity financing. Due to the existence of taxation law, it leads to shareholders and creditors have non-equal position. The creditors are relatively enjoying "preferential treatment", while the shareholders are relatively facing "discrimination". From the aspect of the individual income tax, due to the government levy individual income tax, individuals must pay income tax no matter whether dividends earned by the shareholders’or interests gained by creditors from enterprise. Hence, the amount of dividends and interests that companies pay to shareholders and creditors is not their actual income. If dividend income and interest income tax have different tax rate, shareholders and creditors would have different evaluation on an enterprise. Shareholders and creditors would require different rate of return. And the cost of capital of equity financing and debt will also be different.Systemic research of tax and corporate finance decisions-related issues began in the1950s. In the year1958, Modigliani and Mille have published an article "cost of capital, corporate finance and investment theory" on "American Economic Review" which opens the corporate finance theory into a whole new chapter. After rigorous derivation, they come to a conclusion that under perfectly competitive market, no taxes, no transaction costs, the company’s capital structure and value of the company has no linkage. In other words, the method an enterprise uses in financing does not necessarily affect the value of the company. This theory is called MM theorem. One of the most important hypotheses of MM theory is that there is no existence of tax. However, tax as important source of state revenue exits in a broad way, which makes the MM Theorem contrast to reality. Subsequently, Modigliani and Miller publish an article called "corporate income tax and capital costs" in the year1963, which has incorporated the corporate income tax into the MM model and it comes to completely different conclusions with the MM theory. They believe that under the existence of income tax liabilities, the value of an enterprise which is having liabilities will exceed the value of enterprises without liabilities. The more liabilities exist, the greater the difference is going to be. When the liabilities reach100%, the value of an enterprise will come to its maximum point. It comes to the conclusion that under the existence of income tax, it is advisable that an enterprise should adopt100%debt financing strategy. After this, many foreign scholars take this opportunity and begin to carry out more detailed study of tax and corporate finance decision-making relations which have achieved fruitful results in both theoretical and empirical aspects.In comparison, domestic scholars begin their study on tax and financing decision issues relativity late and the research is still at an early stage. Normally, the researches done by most of domestic scholars are based on China’s tax background. They use already existed foreign theories and models to improve the empirical research. However, it is still blank in the aspect of theoretical researches. There are two main reasons for this. On the one hand, the development of China’s capital market is still not perfect, some tax-related data is difficult to obtain. On the other hand, China is currently in the transition period, the tax policy is not stable (the2002tax reform,2008income tax "imputation tax ") and it is continues adjusting. This will undoubtedly increase the difficulty of the study, while it also increases the significant value of the research. Especially under current economic conditions in China, business development is still immature which leading to irrational behavior inevitably exists during the financing process. However, tax, as an important tool for regulating the economy, could act as a guide in assisting an enterprise to make scientific and reasonable financing decisions. Researching on financing decisions and its tax-related effect also has considerable practical significance.The first chapter is an introduction part which gives a detailed description on the background, purpose and rational of the study as well as significant, difficult and innovative part of the research.The second chapter has reviewed domestic and foreign literature concerning the relationship between taxation and financing decisions.50years after MM Theorem, in-depth and meticulous research has been carried out by foreign scholars regarding the relationship between taxes and financing decisions. Compared with a wide range of foreign research results, the theoretical study of the domestic research regarding taxation and corporate financing decisions issues is relatively limited. Most scholars take into account of tax influence when examining financing decision factors. Only a small number of scholars have done a specific research on the related issues concerning tax and financing decisions.The third chapter has analyzed the taxation effect that could generate to financing decision from a theatrical perspective. Firstly, it defines the concept of financing and taxation effects. Then, it discusses the effect of taxation on corporate finance decision-making mechanism from the aspects of the corporate income tax and individual income tax. And it divides taxation effect into debt tax shield and non-debt tax shield. The relationship between them has also been discussed in a detailed manner. Lastly, it analyzed and introduced MM theorem, Miller model and the tradeoff theory.The fourth chapter analyzes the current status of China’s corporate finance as well as the illustration of tax factors and non-tax factors which affect corporate financing-related decisions. Although China’s financial market is enjoying a rapid development, getting loans from financial institutions financing is still the most commonly adopted channel of corporate financing. There is a rapid growth of corporate bond issuance in recent years. But relative to equity financing, there is still a gap. During the process of making financing decisions, an enterprise has to consider many factors and taxation is only one of them. Relatively speaking, the presence of many non-taxation factors has weakened the impact of the liabilities taxation that laid on to financing decisions, but it does not mean that it does not exist.The fifth chapter is the design of empirical part. It has selected2005-2010Shanghai A-share listed companies for research target, using interest-bearing liabilities rate as explanatory variables, and the marginal tax rate as the explanatory variable with the intention of testing the marginal tax rate and corporate interest rate bearing liabilities. In the mean time, this paper take2008imputation tax as an opportunity to sub-period the regression model in order to examine how the changes of income tax rate would affect the influence of corporate marginal tax rate exert to the significance level of interest-bearing debt ratio.The sixth chapter is conclusions and recommendationsThis paper has several innovations:First, this paper analysis the tax effect of financial decision from the perspective of enterprise income tax and individual income tax. At the same time, to give a further discussion, in this article tax effect is divided into debt tax effect and non-debt tax effect. Second, at present most of the empirical research choose the actual tax rate as tax agent variables, this paper compare marginal tax rate and the actual tax rate in regression analysis to test which one is better. Third, this paper take2008imputation tax as an opportunity to sub-period the regression model in order to examine how the changes of income tax rate would affect the influence of corporate marginal tax rate exert to the significance level of interest-bearing debt ratio.