Corporate Cash Holdings and Tax-induced Debt Financing
Article first published online: 22 MAR 2010
2008 Korean Securities Association
Asia-Pacific Journal of Financial Studies
Volume 37, Issue 6, pages 983–1023, December 2008
How to Cite
Jung, K. and Kim, B. (2008), Corporate Cash Holdings and Tax-induced Debt Financing. Asia-Pacific Journal of Financial Studies, 37: 983–1023. doi: 10.1111/j.2041-6156.2008.tb00001.x
- Issue published online: 22 MAR 2010
- Article first published online: 22 MAR 2010
- Received 08 November 2006; Accepted 03 January 2008.
- Cash Holdings;
- Capital Structure Adjustment;
- Marginal Tax Rate;
- Interest Tax Shields
Stockpiling of liquid assets in cash decreases the possibility of a firm's falling into financial distress and becoming technically insolvent. Such stockpiling provides incentives for firms to increase their leverage because cash holdings decrease potential financial distress costs and increase target debt-equity ratios. This paper examines whether firms' excessive cash holdings enhance an explanatory power of the marginal tax rate for the change in leverage. The results show that high-taxed firms with excess cash are more likely to increase their leverage. The increase in leverage is not to discipline the entrenched managers' discretionary use of free cash, and the excess cash is not simply for planned future investments either. We also find that the results still hold even when the financial crisis periods are excluded and that the debt financing behavior changes with the level of statutory tax rate. These findings provide evidence that firms with sufficient cash are more likely to take advantage of interest tax shields.