Progressive taxation,tax exemption,and corporate liquidation policy

This paper develops a real options model of a firm that operates in continuous time with an infinite horizon. The firm receives stochastic profit flows that are subject to progressive taxation. Tax progression arises from an exogenously given tax exemption threshold that makes the average tax rate increase with the tax base. The firm possesses an option to liquidate its operation, which is optimally exercised when the firm's profit flow reaches an endogenously determined threshold level (the liquidation trigger) from above. We show that the firm's liquidation trigger under progressive taxation increases with either a reduction in the tax exemption threshold or an increase in the corporate income tax rate. Corporate income taxes are thus not neutral when tax schedules are progressive.     

Debt, managerial compensation and learning

Using a dynamic model with uncertainty and asymmetric information, we study the impact of debt and bankruptcy on managerial compensation and learning. In this model, compensation has two roles to play—providing incentives to the manager and learning about his type. We show that debt, through bankruptcy, acts as a substitute of compensation in both dimensions and derive conditions under which debt lowers average compensation, pay-performance sensitivity and increases learning. We also examine the choice of debt and show that firm value can be increased due to debt's effect on managerial compensation, abstracting from other costs and benefits of debt. Finally, we conduct comparative statics with respect to the underlying parameters.     

Overnight borrowing, interest rates and extreme value theory

We examine the dynamics of extreme values of overnight borrowing rates in an inter-bank money market before a financial crisis during which overnight borrowing rates rocketed up to (simple annual) 4000 percent. It is shown that the generalized Pareto distribution fits well to the extreme values of the interest rate distribution. We also provide predictions of extreme overnight borrowing rates using pre-crisis data. The examination of tails (extreme values) provides answers to such issues as to what are the extreme movements to be expected in financial markets; is there a possibility for even larger movements and, are there theoretical processes that can model the type of fat-tails in the observed data? The answers to such questions are essential for proper management of financial exposures and laying ground for regulations.     

Debt and corporate governance in emerging economiesEvidence from India1

We analyze the role of debt in corporate governance with respect to a large emerging economy, India, where debt has been an important source of external finance. Using cross‐sectional data on listed manufacturing firms we estimate, simultaneously, the relation between Tobin's Q and leverage for three years, 1996, 2000 and 2003. Our analysis indicates that while in the early years of institutional change, debt did not have any disciplinary effect on either standalone or group affiliated firms, the disciplinary effect appeared in the later years as institutions became more market oriented. We also find limited evidence of debt being used as an expropriation mechanism in group firms that are more vulnerable to such expropriation. In general, our results highlight the role of ownership structures and institutions in debt governance.     

Dividend taxes,corporate investment,and ‘Q’

Taxes on corporate distributions have traditionally been regarded as a ‘double tax’ on corporate income. This view implies that while the total effective tax rate on corporate source income affects real economic decisions, the distribution of this tax burden between the shareholders and the corporation is irrelevant. Recent research has suggested an alternative to this traditional view. One explanation of why firms in the United States pay dividends in spite of the heavy tax liabilities associated with this form of distribution is that the stock market capitalizes the tax payments associated with corporate distributions. This capitalization leaves investors indifferent at the margin between a corporation's decision to pay out dividends or to retain earnings. This alternative view holds that while changes in the dividend tax rate will affect shareholder wealth, they will have no impact on corporate investment decisions.This paper develops econometric tests which distinguish between these two views of dividend taxation. By extending Tobin's ‘q’ theory of investment to incorporate taxes at both the corporate and personal levels, the implications of each view for corporate investment decisions can be derived. The competing views may be tested by comparing the performance of investment equations estimated under each theory's predictions. British time series data are particularly appropriate for testing hypotheses about dividend taxes because of the substantial postwar variation in effective tax rates on corporate distributions. The econometric results suggest that dividend taxes have important effects on investment decisions.     

Schooling choices: Preferences, discount rates, and rates of return

This paper develops an empirical model to identify the structural parameters of schooling preferences and human capital production. Our model distinguishes between consumption and investment motives with regard to schooling. The results show that both motives matter. Preferences for schooling vary with social background and ability. Children from poorer social backgrounds and of lower ability have a lower preference for schooling. The discount rate that enters the net value of lifetime income varies with social background as well. The marginal rate of return to schooling decreases with ability and schooling. On average the marginal rate of return is 7.3 per cent, which can be contrasted with a `Mincerian' rate of return equal to 4.8 per cent. This indicates that the usual OLS estimate underestimates the true rate of return. First version received: November 1997/Final version received: February 1999     

Investment under Uncertainty, Debt and Taxes

It is common practice in financial derivative valuation to use a discount factor based on the riskless debt rate. But, to what extent is this discount factor appropriate for cash flows emerging in capital budgeting? To answer this question, we introduce a framework for real asset valuation that considers both personal and corporate taxation. We first discuss broad circumstances under which personal taxes do not affect valuation. We show that the appropriate discount rate for equity‐financed flows in a risk‐neutral setting is an equity rate that differs from the riskless debt rate by a tax wedge due to the presence of personal taxation. We extend this result to the valuation of the interest tax shield for exogenous debt policy with default risk. Interest tax shields, which accrue at a net rate corresponding to the difference between the corporate tax rate and a tax rate related to the personal tax rates, can have either positive or negative values. We also provide an illustrative real options application of our valuation approach to the case of an option to delay investment in a project, showing that the application of Black and Scholes formula may be incorrect in presence of personal taxes.     

Repatriation taxes, repatriation strategies and multinational financial policy

Several investment-repatriation strategies are added to the standard model of a multinational in which an affiliate is located in a low-tax country and is limited to two alternatives: repatriating taxable dividends to the parent or investing in its own real operations. In our model, affiliates can invest in passive assets, which the parent can borrow against, or in related affiliates which can be used as vehicles for tax-favored repatriations. We show analytically how the availability of alternative strategies can effect real investment throughout the worldwide corporation. We use firm level data for US multinationals to test for the importance of alternative strategies. The evidence is generally consistent with the theory, particularly the strategies using related affiliates.     

Entry cost, the Tobin tax, and noise trading in the foreign exchange market

Abstract .  Two types of policy have been proposed to eliminate noise trading in the foreign exchange market: increasing the entry cost or imposing a 'Tobin tax' type of transaction tax. In this paper, we endogenize entry decisions of both informed traders and noise traders and show that these policies may be ineffective in reducing exchange rate volatility. This is because these policies will discourage the entry of all traders, so they may not change the relative ratio of traders, or they may affect informed traders disproportionately more, which increases the relative ratio of noise traders and exchange rate volatility.     

Interest rates,inflation, and taxes: The foreign connection

In this note it is shown that the existence of taxes on nominal interest receipts in an international setting introduces a non-neutrality in that a change in expected inflation in one country must change at least one expected real interest rate or the path of the real exchange rate.     

Mergers and corporate debt financing

We investigate the effect of mergers on corporate debt financing using time series analysis. We find that corporate debt use increases during periods of very high merger activity but is not significantly affected by variations within the normal range of merger activity. Traditional trade-off and pecking order variables also significantly affect corporate financing choice.     

Financial Frictions and Risky Corporate Debt

We offer clarifications on Cooley and Quadrini (2001) regarding financial frictions and risky corporate debt pricing. Even in a frictionless world, the promised rate on corporate debt is not identical across firms and across capital structures and it is not equal to the risk-free rate. Frictions are unnecessary for credit spreads to arise. Only if the macroeconomy is in actuality risk free or risk neutral do interest rates on corporate debt reflect default probabilities. To the extent that the firm's entire financial structure is traded, a bias in credit spreads introduces an exploitable arbitrage opportunity. Re-establishing no-arbitrage, firm dynamics move in the opposite direction to Cooley and Quadrini's.     

Monetary policy,corporate profit and house prices

By using portfolio theory, we explain the highly observed correlation between the seemingly unrelated corporate profit and house prices in the United States. We test the predictions of the underlying model using a vector autoregression representation and find the data to be supportive of the theory. Monetary impulses explain high correlation as both corporate profit and house prices exhibit similar dynamics in response to a monetary impulse. Robustness checks are presented by using the federal funds rate instead of the monetary base as a measure of the stance of monetary policy and by using other model variations. In all cases, the results are robust.     

Comparing ad valorem and specific taxes with corporate social responsibility

This paper examines the welfare ranking of indirect tax systems with corporate social responsibility (CSR) in a duopoly. Findings show that the two firms' cost and CSR asymmetries both play important roles. If the cost-efficient firm has a higher CSR level, the standard result in traditional tax theory is sustainable. Namely, ad valorem tax (specific subsidy) policies are considered superior to specific tax (ad valorem subsidy) policies. However, if the cost-inefficient firm has a significantly higher CSR level, the standard result is reversed. This result remains robust in an oligopoly model or under a tax revenue constraint.     

Debt, interest rates, and integration of financial markets

It is commonly believed that higher budget deficits raise interest rates. However, these crowding out effects of increasing public debt have usually been found to be small or non-existent. One explanation is that on globalised bond markets interest rate differentials are offset due to financial integration. This paper tests crowding out, and measures the degree of integration of government bond markets, using spatial modelling techniques. Our main finding is that the crowding out effect of public debt on domestic long term interest rates is small: a 1% increase in the debt ratio pushes up domestic rates by 2 pp at most. Financial integration implies an important spillover effect via international bond markets, but only between OECD, and in particular EU, countries. The feedback effect from these markets on long term interest rates is as important as the domestic crowding out effect of higher public debt. Emerging markets are not as well integrated into international capital markets, causing a stronger crowding out effect.     

Individual discount rates forecast county-level unemployment change

We use a national survey to estimate individuals’ discount rates for job creation in the community and test whether impatience for jobs is associated county-level unemployment change outcomes in subsequent years. Our results suggest that impatience for jobs is a possible forecast variable for future modelling efforts. To explore whether the impatience effect is general or simply limited to attitudes about local job creation, the same survey asked about discount rates for local amenity development and personal financial windfall. We find that job growth discount rates perform best for forecasting.     

Heterogeneous firms,corporate taxes and export behavior: A firm-level investigation for Italy

This paper analyses the effect of home corporate taxes on a firm’s decision to expand the scale of its activity through exports using a rich dataset on Italian firms. Starting out from the observation that firms’ export activity vary greatly among them and tend to be systematically related to firm’s characteristics, we relate differences in firms’ export choices to firm level incidence of corporate taxes. Our results suggest that (i) corporate taxes matter at both the extensive and the intensive margin and (ii) higher corporate taxes may increase the probability of new firms’ entry in the foreign market while they decrease the export intensity of incumbent exporters.     

Expenditure taxes,income taxes,and time-inconsistency

Traditional welfare-based comparisons of different tax structures implicitly assume that the government can precommit to its future optimal policy. When optimal tax rates are time- inconsistent, however, such comparisons may be misleading. This paper uses a two-period representative-consumer optimal taxation model to study the implications of time-consistency for the welfare rankings of expenditure and income taxation. I show that the welfare rankings of optimal policies may not be preserved by time-consistent ones.