Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 841: Does the Debt Tax Shield Distort Ownership Efficiency?

Pehr-Johan Norbäck (), Lars Persson () and Joacim Tåg ()
Additional contact information
Pehr-Johan Norbäck: Research Institute of Industrial Economics (IFN), Postal: P.O. Box 55665, SE-102 15 Stockholm, Sweden
Lars Persson: Research Institute of Industrial Economics (IFN), Postal: P.O. Box 55665, SE-102 15 Stockholm, Sweden
Joacim Tåg: Research Institute of Industrial Economics (IFN), Postal: P.O. Box 55665, SE-102 15 Stockholm, Sweden

Abstract: The tax laws of most developed countries are debt biased since firms can deduct interest on debt but not on equity. This bias is known to distort investment decisions. However, less is known about how the debt tax shield affects the ownership of assets when bidders differ financial expertise and thus in optimal use of leverage. We show that the debt tax shield need not always distort ownership efficiency. Assets end up with the socially preferred owner when differences in financial and productive expertise between bidders are small and better financial expertise reduces expected bankruptcy costs.

Keywords: Acquisitions; Capital Gains Tax; Corporate Tax; LBOs; Mergers and Acquisitions; Ownership; Private Equity; Tax Shields

JEL-codes: D20; G32; G33; G34; H25; H32; L19; L22

17 pages, First version: June 11, 2010. Revised: September 22, 2017.

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