Deleveraging, Tax and Corporate Policies

Abstract

Exploiting a government-initiated deleveraging program, we investigate how marginal corporate tax rate affects corporate policy changes in response to a credit shock. We find that, after the initiation of China’s 2015 deleveraging program, high-tax-rate firms reduce leverage to a less extent compared with low-tax-rate firms. This effect is stronger in non-state-owned firms and firms with less non-debt tax shields. High-tax-rate firms reduce dividend and switch to equity financing to a less extent. Through retaining more debt, high-tax-rate firms cut less investments in fixed assets, R&D and human capital. With this unique deleveraging setting, we reveal important implications of the tax-leverage link for corporate policies.

Keywords: deleveraging, marginal corporate tax rate, capital structure, investment, state ownership