We re-examine the claim that many corporations are underleveraged in that they fail to take full advantage of debt tax shields. We show prior results suggesting underleverage stems from biased estimates of tax benefits from interest deductions. We develop improved estimates of marginal tax rates using a non-parametric procedure that produces more accurate estimates of the distribution of future taxable income. We show that additional debt would provide firms with much smaller tax benefits than previously thought, and when expected distress costs and difficult-to-measure non-debt tax shields are also considered, it appears plausible that most firms have tax-efficient capital structures.

The American Jobs Creation Act of 2004 (the Act) creates a temporary tax holiday that effectively reduces the U.S. tax rate on repatriations from foreign subsidiaries from 35% to 5.25%. Firms receive the reduced tax rate by electing to take an 85% dividends received deduction on repatriations in 2004 or 2005. This paper investigates the characteristics of firms that repatriate under the Act and how they use the repatriated funds. We find that firms that repatriate under the Act have lower investment opportunities and higher free cash flows than nonrepatriating firms. Further, we find that repatriating firms increase share repurchases during 2005 by approximately $60 billion more than nonrepatriating firms, an amount that cannot be explained by differences in earnings between the two groups of firms. This increase represents about 20% of the $291.6 billion repatriated by our sample firms under the Act.

Our study evaluates the role of coordination, at both the government and the firm level, on the transfer prices set by U.S. multinational corporations ( MNC s) when income taxes and duties cannot be jointly minimized with a single transfer price. We find that either the presence of a coordinated income tax and customs enforcement regime or coordination between the income tax and customs functions alters transfer prices for these firms. Our analyses have implications for both firms and taxing authorities. Specifically, our findings suggest that MNC s might decrease their aggregate tax burdens by increasing coordination within the firm or that governments might increase their aggregate revenues by improving coordinating enforcement across taxing authorities. Our study is novel in that we document, in a specific setting, how coordination influences MNC s’ tax reporting behavior.

Individual investors have an incentive to defer selling appreciated stock until it qualifies for tax‐favored, long‐term capital gains treatment. Shackelford and Verrecchia [2002] show that these incentives can affect equity trading around public disclosures. This article provides some empirical support for their theory with evidence of price increases and equity constrictions around announcements of quarterly earnings and additions to the S&P 500 index. We find share returns rise and trading volume falls with the incremental taxes saved by deferring the sale of appreciated property. The price increases, however, are temporary, reversing in subsequent trading days. The results are consistent with buyers believing the compensation to sell before long‐term qualification (through higher prices) is less costly than holding an inappropriately weighted portfolio. This finding—that personal capital gains taxes affect equity trading—adds to a growing literature that challenges longstanding assumptions that firm value is independent of shareholders and their taxes.

We use a proprietary data set with detailed executive compensation information to examine the relationship between the incentives of the tax director and GAAP and cash effective tax rates, the book-tax gap, and measures of tax aggressiveness. We find that the incentive compensation of the tax director exhibits a strong negative relationship with the GAAP effective tax rate, but little relationship with the other tax attributes. We interpret these results as indicating that tax directors are provided with incentives to reduce the level of tax expense reported in the financial statements.

We investigate whether aggressive tax planning firms have a less transparent information environment. Although tax planning provides expected tax savings, it can simultaneously increase the financial complexity of the organization. And to the extent that this greater financial complexity cannot be adequately clarified through communications with outside parties, such as investors and analysts, transparency problems can arise. Our investigation of the association between tax aggressiveness and information asymmetry, analysts' forecast errors, and earnings quality suggests that aggressive tax planning is associated with lower corporate transparency. We also find evidence that managers at tax-aggressive firms attempt to mitigate these transparency problems by increasing various tax-related disclosures. Overall, our results suggest that firms face a trade-off between tax benefits and financial transparency when choosing the aggressiveness of their tax planning.

This study jointly evaluates firm-level changes in investor composition and shareholder distributions following a 2003 reduction in the dividend and capital gains tax rates for individuals. We find that directors and officers, but not other individual investors, rebalanced their portfolios to maximize after-tax returns in light of the new tax rules. We also find that firms adjusted their distribution policy (specifically, dividends versus share repurchases) in a manner consistent with the altered tax incentives for individual investors. To our knowledge, this is the first study to employ simultaneous equations to estimate both shareholder and managerial responses to the 2003 rate reductions. We find that the generalized method of moments (GMM) estimates are substantially stronger than OLS estimates, consistent with our expectation that investor and manager responses are simultaneously determined. Failure to estimate systems of equations may account for some of the weak and conflicting results from prior studies of the 2003 rate reductions.

We study the impact of the Domestic Production Activities Deduction (DPAD) on mergers and acquisitions. DPAD reduces corporate tax rates on income from work or goods made in the U.S. Results indicate that the quantity and quality of acquisition bids by DPAD-advantaged firms conform to the predictions of the neoclassical theory of the firm and the theory of financial constraints. Specifically, bids, particularly those cash-financed, increase substantially in industries with large DPAD-related tax cuts and for firms with financial constraints. Moreover, DPAD improves acquisition quality where acquirers and targets are likely to generate incremental DPAD tax benefits through their merger.

We examine how shareholder-level taxes affect the contemporaneous pricing of foreign firms' U.S. cross-listed and underlying home-country securities surrounding the 1997 reduction in U.S. capital gains tax rates. Consistent with tax capitalization, we find that the performance of cross-listed shares is negatively related to dividend yield, suggesting an abnormal price increase for shares with greater anticipated taxable capital gains. Due to barriers to cross-border arbitrage, underlying home-country securities, on average, do not react during the event, creating a temporary tax-induced pricing spread. When costs of arbitrage are low, the pricing disparity quickly dissipates and home-country shares closely mirror the pricing of their cross-listed counterparts. In further tests, we are unable to document lock-in behavior, which predicates a decrease in prices attributable to a surge in volume for shares with greater accrued taxable capital gains. Overall, our findings suggest that an exogenous shock to the U.S. tax regime reverberates in international asset prices, thereby affecting foreign firms' costs of capital.