Debt Management under Corporate and Personal Taxation

Authors

  • DAVID C. MAUER,

  • WILBUR G. LEWELLEN

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    • The University of Wiconsin at Madison and Purdue University, respectively. Helpful comments and suggestions by Amir Barnea, Mark Finster, Bill Kracaw, Shehzad Mian, Lemma Senbet, Gwang-Fen, She, Howard Thompson, and Joe Williams are gratefully acknowledged.

ABSTRACT

The presence of long-term debt in a corporation's capital structure is shown to give rise to a valuable tax-timing option that can be exercised by the firm on behalf of its shareholders. This option, which is not available if the firm is fully equity financed, implies that leverage will have a positive tax effect on total firm value even if there is no such effect associated with the tax deductibility of the coupon interest payments on debt. The more volatile interest rates and bond prices are, the more valuable the tax-timing option and the larger the favorable impact of debt on shareholder wealth.

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