LAW & ECONOMICS WORKSHOP SERIES
presents
Craig Doidge and Alexander Dyck
Rotman School of Management, University of Toronto
Taxes, Valuation and Organizational Structure: Evidence from Canada
(by Craig Doidge, Alexander Dyck and Laurence Booth)
Wednesday, November 12, 2008
12:30 – 2:00
Solarium (Room FA2) – Falconer Hall - 84 Queen’s Park
Does the availability of a financing mechanism that lowers corporate taxes translate directly into an increase in firm value? If so, what is the value of a tax shield and does advantageous tax treatment influence firm organizational choices? Despite the fundamental importance of such questions in corporate finance, there are no settled answers. As Miller (1977) and others have argued, personal income taxes can reduce or even eliminate the value of tax shields at the corporate level, and under these circumstances taxes should not affect organizational choices. A public finance perspective suggests a potentially equally important concern. The value of a tax shield can be lowered, if not eliminated, by competitive effects that force those with access to tax shields to pass on this benefit in lower prices to consumers. And as Graham (2003) reminds us, empirical work to overcome such theoretical ambiguity has been limited by the difficulty of identifying the impact of tax shields and developing proxies for the tax status of the marginal investor.
This paper takes advantage of the rise and fall of the income trust structure in Canada to estimate the value of a tax shield, to identify organizational responses to advantageous tax treatment, and to see to what extent personal taxes and competition affects the value of tax shields. The income trust structure, whereby publicly traded firms could avoid almost all corporate taxes, transformed the Canadian equity market landscape, with $200 billion in market value as many established traded firms converted to this structure and new firms entered public markets with this structure. Two facts about this structure aid our empirical efforts: first the government made a surprise announcement to phase out of the trust structure on October 31, 2006, providing us with a market estimate of the value of the tax shield; second, income trusts were regular and large dividend payers allowing us to exploit the ex-dividend response of Elton and Gruber (1970) to identify the marginal investor and their tax status.
A light lunch will be provided.
For more workshop information, please contact Nadia Gulezko at n.gulezko@utoronto.ca
