Agency costs,taxes and debt: The UK evidence

This paper provides an empirical examination of the impact of the corporation tax and agency costs on firms' capital structure decisions. Our evidence suggests that the agency costs are the main determinants of corporate borrowing. Consistent with the agency theory, we find that firms that have fewer growth options have more debt in their capital structure. Moreover, our results show that debt mitigates the free cash flow problem and that firms that are more likely to be diversified and less prone to bankruptcy are highly geared. the negative effect of insider shareholding on leverage disappears, however; when all the agency mechanisms are accounted for. In addition, we find that, in the long run, companies that are tax exhausted exhibit significantly lower debt ratios than tax-paying firms. However, in the short run, firms' capital structure decisions are not affected by taxation.     

The effect of taxes on multinational debt location

We provide new evidence that differences in international tax rates and tax regimes affect multinational firms' debt location decisions. Our sample contains 8287 debt issues from 2437 firms headquartered in 23 different countries with debt-issuing subsidiaries in 59 countries. We analyze firms' marginal decisions of where to issue debt to investigate the influence of a comprehensive set of tax-related effects, including differences in personal and corporate tax rates, tax credit and exemption systems, and bi-lateral cross-country withholding taxes on interest and dividend payments. Our results show that differences in personal and corporate tax rates, the presence of dividend imputation or relief tax systems, the tax treatment of repatriated profits, and inter-country withholding taxes on dividends and interest significantly influence the decision of where to locate debt and the proportion of debt located abroad. Our results are robust to firm and issue specific factors and to the effect of legal regimes, debt market development, and exchange rate risk.     

Directors’ and Officers’ Liability Insurance and Aggressive Tax‐Reporting Activities: Evidence from Canada

This paper examines the relationship between directors’ and officers’ liability insurance (D&O insurance) and firms’ aggressive tax reporting. Using large Canadian public companies listed on the TSX300 and relying on several measures to capture aggressive tax‐reporting activities, including GAAP effective tax rates, cash effective tax rates, and the total and residual book‐tax differences, I find that D&O insurance exhibits a strong negative relationship with the GAAP effective tax rates and a strong positive relationship with both the total and residual book‐tax differences. However, there is generally no evidence showing that D&O insurance is associated with the cash effective tax rates. I interpret these results as indicating that D&O insurance reduces the tax expenses reported in the financial statements but not the actual tax paid. In other words, D&O insurance contributes to financial tax management but not to cash tax savings. Further tests in this study reveal that firms with fluctuating D&O coverage limits engage in more aggressive tax reporting than other firms, suggesting that managers may consider the level of D&O insurance that they purchase when they make aggressive tax‐reporting decisions.     

Firms' Off-Balance Sheet and Hybrid Debt Financing: Evidence from Their Book-Tax Reporting Differences

We match large U.S. corporations' tax returns during 1989–2001 to their financial statements to construct a firm‐level proxy of firms' use of off‐balance sheet and hybrid debt financing. We find that firms with less favorable prior‐period Standard & Poor's (S&P) bond ratings or higher leverage ratios in comparison to their industry report greater amounts of interest expense on their tax returns than to investors and creditors on their financial statements. These between‐firm results are consistent with credit‐constrained firms using more structured financing arrangements. Our within‐firm tests also suggest that firms use more structured financing arrangements when they enter into contractual loan agreements that provide incentives to manage debt ratings. Specifically, we find that after controlling for S&P bond rating and industry‐adjusted leverage, our sample firms report greater amounts of interest expenses for tax than for financial statement purposes when they enter into performance pricing contracts that use senior debt rating covenants to set interest rates. Furthermore, we find that the greatest book‐tax reporting changes occur when firms become closer to violating these debt rating covenants. These latter findings are consistent with firms' contractual debt covenants influencing their use of off‐balance sheet and hybrid debt financing.     

IRS Private Letter Rulings: Initial Evidence on Determinants and Consequences

This study examines the determinants of firms' requests for Private Letter Rulings (PLRs) from the US Internal Revenue Service (IRS) and their impact on firms' cash holdings. Our results show that PLR requests tend to be made by firms with more active tax planning, more acquisitions, higher analyst following, higher leverage, and less in-house tax expertise. We also show that firms with IRS audit red flags are less likely to request a PLR. We use a difference-in-difference approach to assess changes in cash holdings following PLR requests and report a decrease in cash holdings for PLR firms, consistent with the notion that PLRs act to reduce tax uncertainty. Our study provides the first empirical evidence about the determinants of PLR requests and complements prior work on tax uncertainty and cash holdings (Hanlon, Maydew and Saavedra, 2017).     

PRODUCTION TECHNOLOGY,NONDEBT TAX SHIELDS,AND FINANCIAL LEVERAGE

In the literature a negative relationship between debt and nondebt tax shields is predicted only for firms that have the same production technology (i.e., firms with perfectly correlated pretax output). In this paper we examine the relationship between production technology and differences in firms' financial leverage ratios, and find that firms in the same industry with highly (lowly) correlated output make similar (dissimilar) leverage decisions. Thus, the correlation of output across states of nature helps explain leverage differences that are not explained by industry differences. Contrary to previous predictions, however, leverage differences for firms with highly correlated pretax output suggest a positive relationship between debt and nondebt tax shields.     

Apple's agency model and the role of most‐favored‐nation clauses

The agency model used by Apple and other digital platforms delegates retail‐pricing decisions to upstream content providers subject to a fixed revenue‐sharing rule. Given competition both upstream and downstream, we consider how, under the agency model, retail prices depend on the firms' revenue‐sharing splits and the degrees to which consumers view the platforms and the goods sold on the platforms to be substitutes. We show that the agency model may not be universally adopted even if adoption would mean higher profits for all firms. Use of most‐favored‐nation clauses in these settings can ensure industry‐wide adoption and increase retail prices.     

Real Options Valuation: A Case Study of an E‐commerce Company

This paper presents a real options valuation model with original solutions to some issues that arise frequently when trying to apply these models to real‐life situations. The authors build on existing models by introducing an innovative and intuitive risk neutral adjustment that allows us to work with all the simulated paths. The problem of incorporating real options into each path is solved with a “nearest neighbors” technique, and uncertainty is simulated using a beta distribution that adapts better to company‐specific information. The model is then applied to a real life e‐commerce company to produce the following insights: the expanded present value is higher than the traditional present value; the presence of several real options make them interact so that their values are nonadditive; and part of the expanded present value is explained by the presence of “Jensen's inequality” that stems from the “convexity” between the value of each year's cash flow and the uncertain variables.     

Dividend Policies of Privately Held Companies: Stand‐Alone and Group Companies in Belgium

This study examines the dividend policies of privately held Belgian companies, differentiating between stand‐alone companies and those affiliated with a business group. We find that privately held companies typically do not pay dividends. Compared to public companies, they are less likely to pay dividends and they have lower dividend payouts. Our results also suggest that group companies pay more dividends than stand‐alone companies, consistent with the hypothesis that tax‐exempt group firms redistribute dividend payments on the group's internal capital market. Group companies pay higher dividends if they have minority shareholders.     

Business Tax reform and CSR engagement: Evidence from China

This study investigates the impacts of tax incentives on firms' CSR engagement. Using the staggered Business Tax reform in China as exogenous shocks, our difference-in-differences estimation shows that tax incentives facilitate firms' CSR disclosure, and a plausible mechanism is the released financial burden. The result remains valid under a battery of robustness checks and is more pronounced for state-owned firms, firms with tighter political connections, firms with transparent information and firms locate in areas with higher degree of social trust. The study provides clear policy implications by elaborating on the favorable impacts of tax incentives on firms' CSR performance.     

Factors Influencing Corporate Environmental Disclosures

We investigate the effectiveness of the Carbon Disclosure Project (CDP), a not‐for‐profit organization that facilitates environmental disclosures of firms with institutional investors, thereby serving as a corporate governance mechanism for shareholders to influence the firm's environmental disclosures. We examine firm characteristics associated with firms' decisions to disclose carbon‐related information via the CDP for a sample of 319 Canadian firms over a four‐year period. In particular, we examine how firms' decisions to disclose via CDP are associated with shareholder activism, litigation risk, and the opportunity for low‐cost positive publicity once requested by the firms' “signatory” investors. Our results also show that management's decision to release climate change data is associated with domestic, but not foreign, signatory investors. We also find that disclosing firms tend to be those from lower polluting industries with less exposure to litigation risk. This suggests that this new form of coordinated shareholder activism may not be successful at altering the behavior of firms that are heavier polluters.     

Leverage and Taxes: Evidence from the Real Estate Industry

Finance theory has long viewed corporate income taxes as a potentially important determinant of corporate financing decisions and capital structures. But finance academics have been unable to provide convincing empirical evidence of a material effect of taxes on corporate leverage, in part because of difficulties in constructing an effective proxy for marginal corporate tax rates, and hence for the tax benefits of debt, for large samples of individual companies. The authors address this by analyzing leverage decisions in an industry whose publicly traded entities are organized either as taxable corporations, or as real estate investment trusts (REITs) that effectively avoid entity level taxation. This enables them to measure the relative tax benefits of debt with greater precision while controlling for important nontax characteristics that affect debt usage. The tax hypothesis predicts that for real estate firms with similar asset portfolios, taxable firms should have more debt than their nontaxable counterparts. Both the nontaxable and the taxable real estate firms in our sample routinely have more than twice the leverage of industrial firms, which suggests that factors other than taxes are contributing to their use of debt. But among real estate firms, tax status appears to play a much weaker role. Taxable firms have significantly more leverage only after 2000, when restrictions on REITs were removed through new regulations that made their operations much more like those of taxable real estate firms. Our findings also depend on real estate characteristics—most notably, only residential real estate firms demonstrated differences that are consistent with the tax hypothesis. Taken together, the authors’ findings suggest that although taxes do seem to matter, their role is clearly secondary relative to factors such as the nature of the firm’s assets. A generous interpretation of our evidence puts the effect of taxes between one‐third and one‐half of that implied by prior research.     

Accounting Discretion in Fair Value Estimates: An Examination of SFAS 142 Goodwill Impairments

This study examines Statement of Financial Accounting Standards 142 adoption decisions, focusing on the trade‐off between recording certain current goodwill impairment charges below the line and uncertain future impairment charges included in income from continuing operations. We examine several potentially important economic incentives that firms face when making this accounting choice. We find evidence suggesting that firms' equity market concerns affect their preference for above‐the‐line vs. below‐the‐line accounting treatment, and firms' debt contracting, bonus, turnover, and exchange delisting incentives affect their decisions to accelerate or delay expense recognition. Our study contributes to the accounting choice literature by examining managers' use of discretion when adopting a mandatory accounting change and by developing and testing explicit cross‐sectional hypotheses of the determinants of firms' preferences for immediate below‐the‐line versus delayed above‐the‐line expense recognition.     

Do personal taxes affect capital structure? Evidence from the 2003 tax cut

Because the personal tax treatments of interest and dividend income likely affect the relative cost of debt and equity financing, a sharp change in tax treatment could affect firms' optimal leverage. This paper examines the effect of the 2003 equity income tax cut on firms' debt usage. Because this tax cut affected only individual investors, we can use a difference-in-differences method to identify the effect of personal tax on firms' leverage. Previous research has found that the 2003 tax cut encouraged dividend payouts and reduced the cost of equity, but it provides no link to equilibrium leverage ratios. We estimate that the tax cut causes the affected firms' leverage to decrease by about 5 percentage points. Furthermore, we show that the effects of the tax cut are stronger for firms with lower marginal corporate tax rates and for firms that are not financially constrained, consistent with our theoretical predictions. Overall, we find strong evidence that personal tax is an important determinant of firms' optimal leverage.     

Antecedents and Consequences of Eco‐Control Deployment: Evidence from Canadian Manufacturing Firms

Environmental issues have become an important consideration for a growing number of organizations. Eco‐control may represent a valuable tool to help organizations address such issues. The aim of this study is to provide an overview of the eco‐control practices adopted by Canadian organizations and to understand the antecedents and consequences of their adoption. More specifically, this study examines (i) the extent to which eco‐control practices are deployed within organizations, (ii) the factors and motivations that lead organizations to implement eco‐control practices, and (iii) the impact of adoption on firms’ managerial and operational environmental actions as well as on environmental and economic performance. Using survey data from a sample of 249 Canadian manufacturing firms, this article shows that environmental missions, environmental policies, environmental strategic planning, environmental budgets and environmental performance indicators are the most frequently adopted eco‐control practices among the investigated firms, while environmental incentives seem to be less frequently adopted. The results of this study also suggest that competitive and ethical motivations as well as size, environmental exposure and stakeholder pressure are all important factors in explaining eco‐control practice adoption by Canadian manufacturing firms. Moreover, the results of this study show that organizations that have undertaken more intensive managerial and operational environmental actions have also adopted more intensive eco‐control practices. Organizations adopting more intensive eco‐control practices perform better both environmentally and economically performance than firms adopting less intensive eco‐control practices.     

CAP Forum on E‐Business: Compromise or Customize: XBRL's Paradoxical Power

Business reports are changing in response to regulatory and market demands. Requests by regulators for electronic filings of financial statements and tax forms are increasing and such filings are rapidly becoming mandatory in many countries. In response, extensible business reporting language (XBRL) is a market‐driven, collaborative effort to make electronic filings more useful to, and to reduce the burden on, both publishers and consumers of business reports. XBRL does much more than simply list data items that can be submitted in an electronic filing. XBRL is a complete set of tools for regulators or groups to fully communicate the meanings of and interrelationships among the business reporting concepts. In addition, core sets of concepts from regulators or groups can be extended, expanded, or otherwise modified for more specific communication by jurisdictions, industries, or individual corporations. This unique customization capability lets companies better present their electronic filings as parallels to their paper filings. A “customizable standard” offers new opportunities and new challenges. This paper discusses XBRL's paradoxical power ‐ the trade‐offs between customizing to better parallel existing paper reports and compromising to more closely match the standards, and the research needed for the transition from freeform to customized reports.     

Labor‐Technology Substitution: Implications for Asset Pricing

This paper studies the asset pricing implications of a firm's opportunities to replace routine‐task labor with automation. I develop a model in which firms optimally undertake such replacement when their productivity is low. Hence, firms with routine‐task labor maintain a replacement option that hedges their value against unfavorable macroeconomic shocks and lowers their expected returns. Using establishment‐level occupational data, I construct a measure of firms' share of routine‐task labor. Compared to their industry peers, firms with a higher share of routine‐task labor (i) invest more in machines and reduce more routine‐task labor during economic downturns, and (ii) have lower expected stock returns.     

Agency and Tax Explanations of Security Issuance Decisions

This paper is an empirical examination of the relative roles of agency and tax considerations in corporate debt versus equity issuance decisions. Unlike earlier work, we conduct our tests on a sample of UK firms since the UK system of taxation does not create an obvious tax advantage to debt and hence affords an opportunity to evaluate the relevance of tax arbitrage considerations. We find that both tax and agency issues are important determinants of security issuance decisions. In addition, we demonstrate that our specification is robust to a variety of alternative explanations which have appeared in the empirical literature.     

Tax reform and payout policy: Do shareholder clienteles or payout policy adjust?

Changes in taxation of corporate dividends offer excellent opportunities to study dividend clientele effects. We explore payout policies and ownership structures around a major tax reform that took place in Finland in 2004. Consistent with dividend clienteles affecting firms' dividend policy decisions, we find that Finnish firms altered their dividend policies based on the changed tax incentives of their largest shareholders. While firms adjust their payout policies, our results also indicate that ownership structures of Finnish firms also changed around the 2004 reform, consistent with shareholder clienteles adjusting to the new tax system.     

Competitive cross‐subsidization

Cross‐subsidization arises naturally when firms with different comparative advantages compete for consumers with heterogeneous shopping patterns. Firms then face a form of co‐opetition, as they offer substitutes for one‐stop shoppers and complements for multi‐stop shoppers. When intense competition for one‐stop shoppers drives total prices down to cost, firms subsidize weak products with the profits made on strong products. Moreover, firms have incentives to seek comparative advantages on different products. Finally, banning below‐cost pricing increases firms' profits at the expense of one‐stop shoppers, which calls for a cautious use of below‐cost pricing regulations in competitive markets.