Impact of Interest Rate Swaps on Corporate Capital Structure: An Empirical Investigation

Abstract

Interest rate swaps are the most popular financial derivatives used by US firms. In this paper, the effects of swap usage on corporate financing decisions are empirically examined. Based on a dynamic capital structure theoretical model, we employ a seemingly unrelated regression model with a heteroscedasticity-consistent covariance estimator to estimate these effects. The empirical results show that the firms with higher effective tax rates reduce their optimal debt ratio range when they use interest rate swaps. We also found that the swap users may enlarge the influence of firm size on corporate dynamic debt policy, though it was not clear that it helped reduce or increase the optimal debt ratio range. No effect of swaps usage on the optimal debt ratio range was found related to bankruptcy costs and the volatility of income. The findings imply that the use of swaps can help firms stick to an initial high debt ratio and make more use of the large tax benefits of debts on debt financing decisions.

Keywords: interest rate swaps, capital structure, tax incentive of hedging

JEL Classification: C3, G1, G32