TAX OPTIONS AND CORPORATE CAPITAL STRUCTURES
Abstract
This research examines tax-timing options associated with opportunities to tax-trade corporate securities. Firm financing and investment policy decisions are shown to have a significant impact on tax-timing option values. Additionally, a valuable firm tax-timing option is shown to be created when a firm inserts long term debt into its capital structure. In the first part of the thesis, the opportunity for the firm to repurchase its long term debt in the secondary market is shown to give rise to a valuable debt tax-timing option which can be exercised by the firm on behalf of its shareholders. Since the option is not available if the firm is fully equity-financed, its existence 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 second part of the thesis analyzes how optimal tax-trading strategies for individual investors relate to the determination of an optimal corporate capital structure. The existence of debt in a firm's capital structure is shown to increase the set of opportunities to tax-trade the firm's securities, and therefore to increase the after-tax value of the firm. We demonstrate that an optimal capital structure can be generated for any individual firm as a function of the level of debt financing. This result is caused by a shifting of the correlation of debt and equity returns, and therefore tax-trading opportunities, in states of nature where the firm defaults on its debt. The final part of the thesis examines the impact of mergers and spin-offs on aggregate tax-timing option values. We show that mergers will tend to diminish, and spin-offs to enhance, tax option values. Both results are consistent with the available empirical evidence that shareholders of firms engaging in spin-offs receive significant valuation gains, while the shareholders of many firms that merge do not.
Degree
Ph.D.
Subject Area
Finance
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