How Big is the Tax Advantage to Debt?

How Big is the Tax Advantage to Debt?

  • ALEX KANE
  • ALAN J. MARCUS
  • ROBERT L. McDONALD

Article first published online: 30th April 2012 DOI: 10.1111/j.1540-6261.1984.tb03678.x

Abstract


This paper uses an option valuation model of the firm to answer the question, “What magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios?” We incorporate into the model differential personal tax rates on capital gains and ordinary income. We conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms. When it is possible for the value of the underlying assets to jump discretely to zero, differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms. Moreover, if the tax advantage to debt is small, the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt‐to‐firm value ratios.

Sign in to access the full article.

Related articles


Front Matter

Article first published online: 10th February 2016 / DOI: 10.1111/j.1540-6261.1984.tb00831.x

Read Article

AUTHOR INDEX

Article first published online: 10th February 2016 / DOI: 10.1111/j.1540-6261.1984.tb00832.x

Read Article

STYLE INSTRUCTIONS

Article first published online: 10th February 2016 / DOI: 10.1111/j.1540-6261.1984.tb00833.x

Read Article

Back Matter

Article first published online: 10th February 2016 / DOI: 10.1111/j.1540-6261.1984.tb00834.x

Read Article

DISCUSSION

  • PAUL M. HORVITZ

Article first published online: 30th April 2012 / DOI: 10.1111/j.1540-6261.1984.tb03670.x

Read Article

Contingent Claims Analysis of Corporate Capital Structures: an Empirical Investigation

  • E. PHILIP JONES
  • SCOTT P. MASON
  • ERIC ROSENFELD

Article first published online: 30th April 2012 / DOI: 10.1111/j.1540-6261.1984.tb03649.x

Read Article

Are you an Author?


Please read our submission requirements and find out how to submit your paper to the Journal of Finance

Submit a paper