The Comprehensive Tax Gain From Leverage

European Accounting Review, Forthcoming

45 Pages Posted: 20 May 2020

See all articles by Zhenhua Chen

Zhenhua Chen

University of San Diego School of Business

Deen Kemsley

Tulane University - Accounting & Taxation; Tulane University - A.B. Freeman School of Business

Padmakumar Sivadasan

Louisiana State University, Baton Rouge - Department of Accounting

Date Written: April 23, 2020

Abstract

We expand the traditional specification of the tax gain from leverage by accounting for the choice between issuing debt and utilizing internal retained earnings equity. Standard analyses focus solely on the choice between debt and external equity. This results in the traditional tax gain from leverage, which equals the corporate tax benefit from debt minus the partially offsetting personal tax disadvantage. Expanding the debt analysis to include internal equity introduces a third tax component to the gain from leverage: a supplemental personal tax disadvantage. This supplemental disadvantage reflects the personal tax cost of distributing internally-generated equity to investors and using replacement debt. It reduces the overall or comprehensive tax gain from leverage and frequently converts it into a tax loss. Therefore, using debt often is costlier than generally assumed. We provide conceptual support for the comprehensive tax gain, plus some initial empirical support.

Keywords: gain from leverage, debt tax shield, pecking order, capital structure

JEL Classification: G32, H21, H24, H25, H32

Suggested Citation

Chen, Zhenhua and Kemsley, Deen and Sivadasan, Padmakumar, The Comprehensive Tax Gain From Leverage (April 23, 2020). European Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3583861

Zhenhua Chen

University of San Diego School of Business ( email )

Olin Hall
5998 Alcalá Park
San Diego, CA
United States

Deen Kemsley (Contact Author)

Tulane University - Accounting & Taxation ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Padmakumar Sivadasan

Louisiana State University, Baton Rouge - Department of Accounting ( email )

E.J. Ourso College of Business Administration
2800 Business Education Complex
Baton Rouge, LA 70803
United States

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