TY  - JOUR
AU  - Kane,Alex
AU  - Marcus,Alan J.
AU  - McDonald,Robert L.
TI  - How Big is the Tax Advantage to Debt?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 1286
PY  - 1985
Y2  - June 1985
UR  - http://www.nber.org/papers/w1286
L1  - http://www.nber.org/papers/w1286.pdf
N1  - Author contact info:
Alex Kane
Graduate School of IRPS/D-019
University of California, San Diego
La Jolla, CA   92093-0519
Tel: 619/534-5969
E-Mail: akane@ucsd.edu

Alan Marcus
Finance Department
Fulton 334
Boston College
Chestnut Hill, MA  02467
Tel: 617-552-2767
E-Mail: alan.marcus@bc.edu

Robert L. McDonald
Department of Finance  Jacobs Center
Northwestern University
2001 Sheridan Rd.
Evanston, IL  60208-2006
Tel: 847-491-8344
Fax: 847-491-5719
E-Mail: r-mcdonald@northwestern.edu
AB  - This paper uses an option valuation model of the firm to answer the question, "What magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios?" We incorporate into the model differential personal tax rates on capital gains and ordinary income. We conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms. When it is possible for the value of the underlying assets to junip discretely to zero, differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms. Moreover, if the tax advantage to debt is small, the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt-to-firm value ratios.
ER  -