How Big Are the Tax Benefits of Debt?

TLDR

The study estimates the capitalized tax benefit of debt at 9.7 % of firm value (down to 4.3 % net of personal taxes) and examines how firms adjust debt use based on the shape of their tax benefit function. The authors integrate firm‑specific benefit functions and infer debt aggressiveness by analyzing the shape of the tax benefit function. Large, liquid, profitable firms with low distress risk use debt conservatively, driven by product‑market factors, growth options, low collateral, and future‑expenditure planning, and this conservative policy persists over time.

Abstract

I integrate under firm‐specific benefit functions to estimate that the capitalized tax benefit of debt equals 9.7 percent of firm value (or as low as 4.3 percent, net of personal taxes). The typical firm could double tax benefits by issuing debt until the marginal tax benefit begins to decline. I infer how aggressively a firm uses debt by observing the shape of its tax benefit function. Paradoxically, large, liquid, profitable firms with low expected distress costs use debt conservatively. Product market factors, growth options, low asset collateral, and planning for future expenditures lead to conservative debt usage. Conservative debt policy is persistent.