Taxes, Valuation, and Organizational Structure

51 Pages Posted: 27 Feb 2011 Last revised: 14 Mar 2011

See all articles by Craig Doidge

Craig Doidge

University of Toronto - Rotman School of Management

I. J. Alexander Dyck

University of Toronto - Rotman School of Management

Date Written: February 26, 2011

Abstract

This paper estimates the impact of taxes on firm value by taking advantage of a dramatic and completely unanticipated increase in taxes for a group of publicly-traded Canadian firms called income trusts. When the tax rate for income trusts unexpectedly increased from 0% to 31.5%, equity value fell by 21% and firm value fell by 18%, on average. Prospective tax shields mitigate the decline, adding 4.9% to firm value. Consistent with the presence of tax-based investor clienteles, the impact of the tax change depends on the marginal investor’s personal tax status, which influences the value of tax shields. Therefore, simple estimates using the permanent debt approach in the Modigliani and Miller (1963) model substantially overstate the value the market places on tax shields. Finally, this dramatic change in tax policy provides new evidence on the significance of taxes for organizational form choices.

Keywords: Taxes, Firm Value, Tax Shield

JEL Classification: G32, H25

Suggested Citation

Doidge, Craig and Dyck, I.J. Alexander, Taxes, Valuation, and Organizational Structure (February 26, 2011). AFA 2012 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1771003 or http://dx.doi.org/10.2139/ssrn.1771003

Craig Doidge (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6
Canada
416-946-8598 (Phone)

HOME PAGE: http://www.rotman.utoronto.ca/FacultyAndResearch/Faculty/FacultyBios/Doidge

I.J. Alexander Dyck

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S 3E6
Canada
416-946-0819 (Phone)

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