The presence of long-term debt in a corporation's capital structure is shown to give rise to a valuable tax-timing option that can be exercised by the firm on behalf of its shareholders. This option, which is not available if the firm is fully equity financed, implies that leverage will have a positive tax effect on total firm value even if there is no such effect associated with the tax deductibility of the coupon interest payments on debt. The more volatile interest rates and bond prices are, the more valuable the tax-timing option and the larger the favorable impact of debt on shareholder wealth.

ABSTRACT The presence of long‐term debt in a corporation's capital structure is shown to give rise to a valuable tax‐timing option that can be exercised by the firm on behalf of its shareholders. This option, which is not available if the firm is fully equity financed, implies that leverage will have a positive tax effect on total firm value even if there is no such effect associated with the tax deductibility of the coupon interest payments on debt. The more volatile interest rates and bond prices are, the more valuable the tax‐timing option and the larger the favorable impact of debt on shareholder wealth.

ABSTRACT The lessons of the leasing literature concerning the impact of leases on the debt capacity of a firm are reviewed and summarized to establish an approach to the analysis of the corporate bond refunding decision. A general proposition regarding financial obligation parity is established, and from that a clear bond refunding decision rule is developed. Previous debates in the literature about appropriate discount rates and about the appropriate cash flows to be discounted for refunding decisions are clarified.

The literature on leasing has generally concentrated on providing management with a selection criterion for the lease-versus-purchase decision; over the years, a variety of recommendations have been advanced ([1], [3], [6], [8], [16], and [18]). More recent papers, however, have shown that the terms of leasing contracts in a transaction-costless competitive capital market will inevitably be such as to render the stockholders of value-maximizing firms indifferent to that decision ([11] and [12]). Simply put, competition among potential lessors-together with the mandates of securities-price-equilibrating trading activities of investors in lessee and lessor firms—will necessarily drive the present values of the cash flows associated with lease arrangements to parity with direct asset purchase prices.

Louis K. W. Ying, Wilbur G. Lewellen, Gary G. Schlarbaum, Ronald C. Lease, Stock Exchange Listings and Securities Returns, The Journal of Financial and Quantitative Analysis, Vol. 12, No. 3 (Sep., 1977), pp. 415-432

This paper examines the hypothesis that investors will sort themselves out into tax-induced ‘financial leverage clienteless’ in which the common stocks of highly levered firms will be held by individuals with low personal tax rates, while the shares of firms with little or no leverage will be held by individuals with high personal tax rates. Although the idea of financial leverage clienteless has appeared in the literature before, the immediate motivation for this investigation is a recent paper by Merton Miller. In that paper he argues that under the current U.S. tax structure, personal taxes will offset corporate taxes such that in equilibrium the value of any individual firm will be independent of its use of debt financing. We extend his analysis to show specifically the way in which financial leverage clienteles would come about in his assumed tax environment. We then conduct some direct empirical tests of the leverage clientele hypothesis. These tests can also be viewed as indirect tests of Miller's new proposition on the irrelevance of capital structures. The results of the tests are mixed: The relationship between corporate leverage policies and investors' tax rates is statistically significant, but its magnitude is less than would be predicted by the theory.