TY - JOUR
T1 - Taxes, leverage, and the cost of equity capital
AU - Dhaliwal, Dan
AU - Heitzman, Shane
AU - Li, Oliver Zhen
PY - 2006/9
Y1 - 2006/9
N2 - 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.
AB - 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.
UR - http://www.scopus.com/inward/record.url?scp=33746254938&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=33746254938&partnerID=8YFLogxK
U2 - 10.1111/j.1475-679X.2006.00214.x
DO - 10.1111/j.1475-679X.2006.00214.x
M3 - Article
AN - SCOPUS:33746254938
SN - 0021-8456
VL - 44
SP - 691
EP - 723
JO - Journal of Accounting Research
JF - Journal of Accounting Research
IS - 4
ER -