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Employee Stock Options, Corporate Taxes, and Debt Policy


  • John R. Graham,

  • Mark H. Lang,

  • Douglas A. Shackelford

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    • We appreciate excellent research assistance from Courtney Edwards, Allison Evans, Laura Knudson, and Julia Wu and insightful comments from an anonymous referee, Alon Brav, John Core, Richard Frankel, David Guenther, John Hand, Mike Lemmon, Ed Maydew, Hamid Mehran, Vikas Mehrotra, Dan Rogers, Richard Sansing, Jim Schallheim, Jake Thomas, Mike Weisbach, workshop participants at the University of Colorado, Cornell, Duke, MIT, the University of North Carolina, Wharton, and audience participants at the 2003 American Accounting Association and American Finance Association meetings. Bob McDonald and Terry Shelvin's comments were especially helpful. All data were publicly available. Lang was visiting the University of Queensland when the first draft of this paper was completed. Graham acknowledges financial support from the Alfred P. Sloan Research Foundation.


We find that employee stock option deductions lead to large aggregate tax savings for Nasdaq 100 and S&P 100 firms and also affect corporate marginal tax rates. For Nasdaq firms, including the effect of options reduces the estimated median marginal tax rate from 31% to 5%. For S&P firms, in contrast, option deductions do not affect marginal tax rates to a large degree. Our evidence suggests that option deductions are important nondebt tax shields and that option deductions substitute for interest deductions in corporate capital structure decisions, explaining in part why some firms use so little debt.