Capital structure and the 2003 tax cuts

The main purpose of this study is to determine if the 2003 tax cuts caused firms to change their capital structures. I find considerable evidence that a capital structure shift did occur. The median market debt ratio of the sample firms decreased from .078 in 2002 to .046 in 2006. After adjusting for known capital structure determinants like firm size and profitability, the data indicates that beginning shortly after the tax cuts were enacted firms began to shift their capital structures and by the end of 2003 they had, on average, about 4% more equity in their capital structures than expected. This increased to about 6% more equity than predicted in 2004 and remained at about the same level through 2006. The results indicate that no capital structure shift occurred immediately prior to the 2003 tax cuts as firms had, on average, the predicted amount of equity capital in their capital structures in 2002. It was also found that firms that did not pay dividends shifted their capital structures more than dividend payers and that the capital structure changes were facilitated by an increase in internally generated equity funds and by issuing equity and retiring debt.

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Capital Structure ,

Tax Rates ,

Cost of Capital ,