Taxation and Capital Structure Choice: The Role of Ownership

• Published date: 01 July 2015
• Date: 01 July 2015
• DOI: http://doi.org/10.1111/sjoe.12107
• Author: Robert Krämer

Scand. J. of Economics 117(3), 957–982, 2015

DOI: 10.1111/sjoe.12107

Taxation and Capital Structure Choice:

The Role of Ownership∗

Robert Kr¨

amer†

European Commission, B-1040 Brussels, Belgium

robert.kraemer@ec.europa.eu

Abstract

Applying firm fixed-effects estimations to European firm-level data, I analyze how ownership

structure affects the relationship between taxation and capital structure. I find that an increase

in the corporate tax rate affects the debt-to-assets ratio positively, and that this effect is

stronger for firms with concentrated ownership. These results hold independently of whether

firms are standalone or subsidiaries, and are also valid if subsidiaries are divided into

those that are foreign-owned and those domestically owned. Lastly, ownership plays a role

even when controlling for other potentially important determinants of the relation between

corporate taxation and capital structure.

Keywords: Corporate finance; corporate taxation; firm heterogeneity

JEL classification:G32; H24; H25

I. Introduction

This paper is based on the observation that, in capital structure research,

the analysis of firm heterogeneity has received very little attention until

recently. However, not only is such an analysis interesting from an academic

point of view, but it is also highly relevant for policy makers. If tax reforms

aim at minimizing capital structure distortions,1it matters not only that

firms adjust their debt-to-assets ratio with respect to corporate taxation, but

also to what extent they do. Against this background, it would be important

†This paper was prepared before the author joined the European Commission. It should not

be reported as representing the views of the European Commission.

∗This paper is a part of the research project “Steuern, Firmenheterogenit¨

at und Unternehmens-

finanzierung”. I gratefully acknowledge financial support by the Deutsche Forschungsge-

meinschaft (DFG). Also, for excellent comments and suggestions, I am indebted to Alfons

Weichenrieder, Michael Overesch, Vilen Lipatov, Alexander Klemm, Dirk Schindler, two

anonymous referees, and participants in the 7th Norwegian–German Seminar on Public

Economics at CESifo, the 5th RGS Doctoral Conference in Economics at University of

Duisburg-Essen, the Annual Meeting of the IIPF at University of Dresden, and a workshop

on recent developments in corporate tax research at the German Ministry of Finance.

1Klautke and Weichenrieder (2008) show that the costs of distorted capital structures are

indeed not negligible.

CThe editors of The Scandinavian Journal of Economics 2015.

958 Taxation and capital structure choice

to understand the relationship between taxation and capital structure in the

context of firm heterogeneity.

With the present paper, I take a step in this direction and focus on the

structure of ownership as an important dimension of firm heterogeneity.

Recent research on multinationals has shown that corporate taxation and

ownership structure interact via conflicts of interest between majority and

minority shareholders. However, although standard theory provides no an-

swer to the question how ownership and taxation interact in general, there

is no reason to believe that such conflicts of interest should be restricted

to the international context. Against this background, I use a large panel of

European firm-level data and empirically analyze whether and how own-

ership structure affects the marginal corporate and personal tax effects on

leverage. In doing so, I differentiate between standalone firms and sub-

sidiaries with a domestic or foreign ultimate owner; in the following, I also

use the term foreign direct investment (FDI) for the latter group of firms.

This paper is the first to focus on such a broad variety of firm types

in order to empirically assess the effect of ownership structure on the tax–

capital-structure relationship. It does not, however, intend to theoretically

identify the precise channel(s) through which ownership structure interacts

with taxation. In this respect, the results should be best interpreted as

giving a new impulse to incorporate issues relating to firm heterogeneity

into theoretical research on capital structure choice. The findings indeed

suggest that firm heterogeneity is important for the question of how firms

adjust capital structure to taxation, and that ownership structure plays a

crucial role in this context. In particular, the analysis shows the following.

First, corporate taxation affects the debt-to-assets ratio positively. In this

context, firms with a concentrated ownership structure react significantly

more strongly than firms with a dispersed ownership structure.

Second, comparing results for standalone firms and subsidiaries, I find

that the positive concentration effect is present for both groups. However,

it is higher in quantity and significance for subsidiaries. This holds partic-

ularly for subsidiaries that have a foreign ultimate owner.

Third, the ownership effect is robust to controlling for other important

determinants of the relationship between corporate taxation and capital

structure. Tangibility affects the corporate tax effect on leverage positively

for standalone firms and has no signif icant effect for subsidiaries. Loss

carryforwards decrease the corporate tax effect only for subsidiaries, and

firm size has a positive effect for both types of firms.2

The findings of the paper relate to the existing body of literature in the

following ways. First, a few previous papers highlight the importance of

ownership structure for foreign affiliates of multinational firms. Desai et al.

2Further specifications highlight the overall robustness of these results.

CThe editors of The Scandinavian Journal of Economics 2015.