Collateral, Taxes, and Leverage

58 Pages Posted: 27 Nov 2013 Last revised: 24 Sep 2015

Shaojin Li

Shanghai University of Finance and Economics - School of Finance

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Yufeng Wu

University of Illinois at Urbana-Champaign - Department of Finance

Date Written: September 23, 2015

Abstract

We quantify the importance of collateral versus taxes for firms' capital structures. We estimate a dynamic contracting model in which a firm seeks financing and is subject to taxation. In the model, collateral constraints arise endogenously. Optimal leverage stays a safe distance from the constraint, balancing the tax benefit of debt with the cost of lost financial flexibility. Models with different tax rates fit the data equally well, and leverage responds to the tax rate only when taxes are low. We estimate the value of preserving financial flexibility at 7.2% of firm assets, which is comparable to the tax benefit.

Keywords: Collateral, Taxes, Leverage, Limited Commitment, Structural Estimation

JEL Classification: G32, G31, G35

Suggested Citation

Li, Shaojin and Whited, Toni M. and Wu, Yufeng, Collateral, Taxes, and Leverage (September 23, 2015). Available at SSRN: https://ssrn.com/abstract=2360391 or http://dx.doi.org/10.2139/ssrn.2360391

Shaojin Li

Shanghai University of Finance and Economics - School of Finance ( email )

200433
China
86-21-65908391 (Phone)

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yufeng Wu

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

HOME PAGE: http://https://business.illinois.edu/profile/yufeng-wu2/

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