Question

e) The latest US Tax code change placed special emphasis on lowering the corporate tax rate. If that were the only force to consider (such as agency and information for instance along with other tax concers) were relevant, what changes would you expect to see in corporate leverage in the country?

f) You are always worse off going after a privately held firm as opposed to a publicly traded firm since the small number of owners in the former case will be more powerful and able to extract a higher premium in the acquisition. True or False. Please Explain.      

Answer 1

Ques. The latest US Tax code change placed special emphasis on lowering the corporate tax rate. If that were the only force to consider (such as agency and information for instance along with other tax concers) were relevant, what changes would you expect to see in corporate leverage in the country?

Ans. Leverage refers to use of debt financing to finance part of capital for the companies. Based on definition of leverage, corporate leverage here refers to use of debt for financing capital requirements of business. This means the total portion of debt used instead of financing with share capital. Corporates use debts because of the tax deduction advantage on interest paid on debt capital. Where as on shares there is no such advantage available to business. However, debt has fixed periodic payment obligations irrespective of company profits whereas dividend is paid to shareholders only out of profits earned by company. Now reduction of corporate tax rate would lead companies to use more of share capital financing rather than debt financing  because the tax reduction would reduce interest paid on debt advantage deduction. Now companies would prefer to use more of share capital financing as it will not lead to fixed periodic payment obligation like interest on debt, instead they will pay dividend to shareholders only when they earn profits. So, ultimately corporate leverage in the country would decrease.

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