Title: The leverage puzzle - a new perspective

Authors: Madhuparna Kolay; James Schallheim; Kyle S. Wells

Addresses: Pamplin School of Business Administration, University of Portland, Portland, OR, USA ' David Eccles School of Business, University of Utah, Salt Lake City, UT, USA ' Department of Accounting, Finance, and Analytics, College of Business, Utah Tech University, St. George, Utah, 84770, USA

Abstract: This paper provides substantial evidence of the substitution between debt alternative tax shielding and leverage using a new proxy, 'tax-spread', defined as tax expense minus paid taxes. Our study shows that firms with higher tax-spreads have lower leverage levels, a relationship that remains robust across various sensitivity tests. The tax-spread effectively identifies companies involved in tax shelter cases, with no-leverage firms exhibiting tax-spreads that are higher, suggesting less reliance on tax shielding from debt. This inverse relationship persists even after controlling for firm performance and risk factors. Our approach captures a wide range of debt alternative tax shielding, including those from aggressive tax planning and opaque shelters, which are not directly observable from financial statements. Using the raw tax-spread and its absolute value, we account for timing differences and permanent differences arising from tax-favourable activities. Overall, our findings highlight the significant role of debt alternative tax shielding in shaping firms' capital structure decisions, emphasising the need to consider both traditional and novel measures in understanding these dynamics.

Keywords: taxes; tax shielding; capital structure; debt policy.

DOI: 10.1504/JIBED.2024.142499

Journal for International Business and Entrepreneurship Development, 2024 Vol.16 No.3, pp.313 - 332

Received: 02 Sep 2024
Accepted: 05 Sep 2024
Published online: 04 Nov 2024 *

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