Tax and the Cost of Equity Capital: An International Analysis

Abstract

This paper investigates the association between taxes and the cost of equity capital in an international setting that allows for exogenous, cross-sectional variation in corporate and investor tax rates. Using a sample of firms from 33 countries over a 21-year period, we find that the cost of equity capital increases in leverage. This effect decreases in the corporate tax rate as well as the personal tax penalty on interest income relative to equity income, though the significance of this latter result is sensitive to model specification. Further, we find that the cost of equity capital increases in tax penalized dividend income and that cross-border equity investments affect the relation between taxes and the cost of equity capital. In sum, we offer further and confirming evidence, in an international setting, that taxes impact the cost of equity capital.

Keywords: Dividend tax, leverage, cost of capital

JEL Classification: F23, G35, H25, H24