Forex

Miller (1977), Green and Hollifield (2003), and others argue that despite the corporate
tax deduction from using debt, investors pay higher taxes on interest income, leading to a
personal tax penalty for corporate tax usage. If investors face higher interest income tax
relative to capital gains tax, they will demand a premium for holding debt, which is reflected
in the cost of debt and deters firms from using debt, all else equal. Graham (1999) shows that
when empirically modeling debt ratios, a specification that adjusts for personal tax penalty
statistically dominates specifications that do not. Following Graham’s (1999) method of
measuring the personal tax penalty (PTP), we include this measure in our analysis as an
additional cost control variables.

coefficients for the marginal cost curve when including the personal
tax penalty (PTP) as a control variable. We see that firms that face high personal tax penalty
do indeed face higher marginal costs of debt (the coefficient indicating a MC function with a
slope of 0.901 for the fixed intercept varying slope model). This is consistent with Graham’s
(1999) findings. However, the PTP measure is very sensitive to outliers, so we exclude it
from the main specifications.