The relationship between the income taxation and the capital structure of large companies in Brazil

Abstract

This paper is an empirical research that uses analysis of multiple linear regression to test validity of hypotheses related to influence of profit taxation in capital structure of large companies in Brazil. According to the tradeoff theory, encouraged by tax advantage of debt, company appeals to third parties capitals up to the level in which costs related to bankruptcy risks overcome such advantage. Pecking order theory states a hierarchy of financing sources and does not attribute to profit taxation a relevant role in debt explanation. Two hypotheses were submitted to prove: the first one tested validity of tradeoff theory regarding impact of profit taxation in debt. Second hypothesis tested the presence of such relation in the companies with high debt and low taxation level, there are no tax advantage of debt for them. Research was based on average data for the years between 2001 and 2003 of the largest companies based in Brazil according to Revista Exame (Exame Magazine). The main hypothesis of the research was confirmed: there is a positive relation between the profit taxation level and the degree of leverage. Such relation was also verified for companies with high debt and low profit taxation level. Those findings confirmed the highest predictive power of tradeoff theory in detriment of pecking order theory concerning impact of profit taxation on capital structure decision.