Real Determinants of Corporate Leverage

The U.S. corporate tax distorts the behavior of both real and financial decisions. With respect to the former, the variation in depreciation allowances and investment tax credit provisions across types of investments leads to widely vazying effective tax rates, especially since 1981. Financial policy is distorted by the differential treatment of debt and equity. The purpose of this paper is to examine, using firm-level panel data, the relationship between real and financial decisions by corporations, in part to determine the extent to which these biases off set or reinforce each other.Our results are tentative and suggest that patterns of real and financial behavior are only partially consistent with predictions of various capital structure models (e.g. bankruptcy/agency cost, limited taxshield)and that there is no obvious offset on the financial side to the tax bias against investment in structures.