Capital Structure, Corporate Investment, and Investor-Level Taxes: Evidence from a Natural Experiment in Europe

Abstract

We study two court rulings that materially affected dividend taxation in several European countries. The tax changes were not related to economic conditions or part of broader policy initiatives, providing a useful experiment for identifying the effect of taxation on capital structure, payout, and investment decisions. Consistent with theory, we find that dividends and equity issuance decline after these changes. Leverage ratios change little on average but increase substantially for capital-raising firms, which, in theory, are the most affected by the tax changes. Moreover, investment rates decrease for capital-raising firms, consistent with an increase in their after-tax cost of capital.

Keywords: capital structure, corporate investment, payout policy, investor-level taxes

JEL Classification: G32, G35