The Role of Taxes and the Interdependence Among Corporate Financial Policies: Evidence from a Natural Experiment

32 Pages Posted: 7 Jul 2016

See all articles by Jefferson Colombo

Jefferson Colombo

Sao Paulo School of Economics (FGV EESP)

João Caldeira

Universidade Federal de Santa Catarina & CNPq

Date Written: July 3, 2016

Abstract

In this paper, we investigate whether and how firms respond to an exogenous tax variation at the investor level by examining their financial decisions following a tax reform for pension funds in Brazil. Consistent with the tax-preference theory of dividends, we find that after implementation of the new law, firms tend to distribute more tax-deductible dividends - called Interest on Equity (IOE) - when the largest or second largest shareholder is a pension fund rather than other types of agents. Surprisingly, control firms also increased (but less than treated firms) their tax-deductible dividend payments, probably to attract more institutional investors and to reduce their cost of capital. We also find that treated firms reduced their leverage relative to control firms after the new law, suggesting that equity tax shields and debt tax shields act as substitute financial instruments. Overall, our evidence suggests that tax is a first-order determinant of corporate financial decisions and firms adjust their policies in consideration of the interdependence among alternative financial instruments.

Keywords: taxation; dividend policy; interdependence of corporate financial decisions; natural experiment

JEL Classification: G30; G35; G38

Suggested Citation

Colombo, Jefferson and Caldeira, João, The Role of Taxes and the Interdependence Among Corporate Financial Policies: Evidence from a Natural Experiment (July 3, 2016). Available at SSRN: https://ssrn.com/abstract=2804329 or http://dx.doi.org/10.2139/ssrn.2804329

Jefferson Colombo (Contact Author)

Sao Paulo School of Economics (FGV EESP) ( email )

Rua Itapeva 474 s.1202
São Paulo, São Paulo 01332-000
Brazil

HOME PAGE: http://https://eesp.fgv.br/integrante/jefferson-colombo

João Caldeira

Universidade Federal de Santa Catarina & CNPq ( email )

R. Eng. Agronômico Andrei Cristian Ferreira, s/n
Florianópolis, SC Rio Grande do Sul 90480-004
Brazil

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