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Book-Tax Conformity and Capital Structure

51 Pages Posted: 16 May 2014 Last revised: 23 Dec 2016

Bradley S. Blaylock

Oklahoma State University - Spears School of Business

Fabio B. Gaertner

University of Wisconsin - Madison - Department of Accounting and Information Systems

Terry J. Shevlin

University of California-Irvine

Date Written: June 29, 2016

Abstract

We examine the effect of increased book-tax conformity on corporate capital structure. Prior studies document a decrease in the informativeness of accounting earnings for equity markets resulting from higher book-tax conformity. We argue that the decrease in earnings informativeness impacts equity holders more than debt holders because of the differences in payoff structures between debt and equity investments such that increases in book-tax conformity lead to increases in firms’ reliance on debt capital. We exploit a natural experiment in the U.S. and find that firms facing an increase in required book-tax conformity increase leverage relative to other firms. We also provide evidence of an increase in the cost of equity (but not of debt) capital for firms facing an increase in required book-tax conformity relative to control firms and that these increases in cost of equity capital are positively associated with an increase in leverage. Our findings are consistent with firms substituting away from equity and towards more debt in the presence of higher book-tax conformity.

Keywords: Book-tax conformity, leverage, capital structure

JEL Classification: H20, H25, M41

Suggested Citation

Blaylock, Bradley S. and Gaertner, Fabio B. and Shevlin, Terry J., Book-Tax Conformity and Capital Structure (June 29, 2016). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2437196 or http://dx.doi.org/10.2139/ssrn.2437196

Bradley S. Blaylock

Oklahoma State University - Spears School of Business ( email )

430 Business Building
Stillwater, OK 74078
United States

Fabio B. Gaertner (Contact Author)

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

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