Managerial and Corporate Taxes and Debt Contract Design

58 Pages Posted: 18 Nov 2021

See all articles by Chris Armstrong

Chris Armstrong

Stanford Graduate School of Business

Youngki Jang

University of Nebraska at Omaha

Nir Yehuda

University of Delaware - Accounting & MIS

Date Written: November 8, 2021

Abstract

We examine how income taxes—both managerial and corporate—influence the design of firms’ debt contracts and their use of financial covenants in particular. Both levels of taxation have the potential to exacerbate conflicts of interest among creditors, shareholders, and managers and, consequently, should influence the design of their debt contracts. Specifically, a decrease in corporate and an increase in managerial taxes encourage managers to take more risk, accordingly, we predict and find that loans issued following such changes in taxation are more likely to include performance rather than capital covenants. A series of cross-sectional tests provide further insight into the effect of both levels of taxation, and corroborate our main inferences. Overall, our study demonstrates how debt contract layouts change in response to arguably exogenous changes in income taxes—and, in turn, managers’ preferences—for risk.

Keywords: Managerial Taxes, Corporate Taxes, Debt-Contract Design

JEL Classification: M41, G32, H32

Suggested Citation

Armstrong, Chris S. and Jang, Youngki and Yehuda, Nir, Managerial and Corporate Taxes and Debt Contract Design (November 8, 2021). Available at SSRN: https://ssrn.com/abstract=3959097 or http://dx.doi.org/10.2139/ssrn.3959097

Chris S. Armstrong

Stanford Graduate School of Business ( email )

655 Knight Way
E316
Stanford, CA 94305-5015
United States

HOME PAGE: http://https://www.gsb.stanford.edu/faculty-research/faculty/christopher-s-armstrong

Youngki Jang

University of Nebraska at Omaha ( email )

6708 Pine Street
Omaha, NE 68182-0048
United States

Nir Yehuda (Contact Author)

University of Delaware - Accounting & MIS ( email )

Alfred Lerner College of Business and Economics
Newark, DE 19716
United States

HOME PAGE: http://https://lerner.udel.edu/faculty-staff-directory/nir-yehuda/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
97
Abstract Views
355
rank
366,221
PlumX Metrics