It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to historical market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market.

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This paper reviews the theory and evidence regarding the impact of taxation on corporate financial policy. Starting from a basic characterization of the classical corporate income tax and its effects, the analysis focuses on three areas of research: equity policy, debt-equity decisions, and choices regarding ownership structure and organizational form. The discussion stresses the distinction between nominal and more fundamental financial differences for example, in the relationship between borrowing and leasing and that financial policy involves choices not only among different underlying policies but also among characterizations of a given policy. The final section offers some brief reflections on the implications of continuing financial innovation.

There are two tax incentives for corporations to hedge: to increase debt capacity and interest tax deductions, and to reduce expected tax liability if the tax function is convex. We test whether these incentives affect the extent of corporate hedging with derivatives. Using an explicit measure of tax function convexity, we find no evidence that firms hedge in response to tax convexity. Our analysis does, however, indicate that firms hedge to increase debt capacity, with increased tax benefits averaging 1.1 percent of firm value. Our results also indicate that firms hedge because of expected financial distress costs and firm size.

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The traditional view is that interest deductibility encourages firms to use debt financing; however, some argue that the personal tax disadvantage to interest offsets the corporate tax advantage. This paper investigates the degree to which personal taxes affect corporate financing decisions. In crosssectional regressions that control for personal taxes, debt usage is positively correlated with tax rates in each year 1980-1994, with significant coefficients in almost every year. A specification that adjusts tax benefits for the personal tax penalty statistically dominates a specification that does not. The positive (negative) effect of corporate (personal) taxes on debt usage is distinctly identified.

This paper extends the investigation of the effect of managerial motives on hedging policy. I utilize a proxy variable that incorporates CEO incentives to increase risk versus stock price. The variable is directly measured using the characteristics of CEO portfolios of stock and option holdings. Furthermore, CEO risk-taking incentives are modeled as a choice variable to eliminate the simultaneity bias of modeling risk-taking incentives as an exogenous variable. CEO risk-taking incentives are negatively related to net derivative holdings for a large cross-sectional sample of firms. This effect is only weakly apparent in one-stage models of risk management. If modeled as a simultaneous system of equations, a strong negative link between CEO risk-taking incentives and the amount of derivative holdings exists. This result is consistent with the notion that derivatives are used for hedging purposes. Both the characteristics of stock and option holdings are important in determining cross-sectional differences in corporate derivative holdings.

We find that employee stock option deductions lead to large aggregate tax savings for Nasdaq 100 and S&P 100 firms and also affect corporate marginal tax rates. For Nasdaq firms, the median marginal tax rate is 31 percent when option deductions are ignored but falls to 5 percent when one accounts for the deductions. For S&P firms, however, option deductions do not affect marginal tax rates to a large degree. In the spirit of DeAngelo and Masulis (1980), option deductions are important nondebt tax shields that can affect corporate policies. We find evidence consistent with option deductions substituting for interest deductions in corporate capital structure decisions. This evidence may explain in part why some firms use so little debt.

comments and suggestions. All remaining errors are mine. This paper develops a theory of corporate risk-management in the presence of deadweight losses caused by financial distress and tests its implications using a comprehensive dataset of over 3000 non-financial firms. Unlike extant theories that explain only the ex-ante riskmanagement behavior of a firm, I show that the shareholders optimally engage in ex-post risk-management activities even without a pre-commitment to do so. I generate new crosssectional predictions by relating firm characteristics such as leverage and deadweight losses from financial distress to its risk-management incentives. The model predicts a positive relationship between leverage and hedging for moderately leveraged firms. This relationship reverses, however, for highly leveraged firms. Similarly the model produces a non-monotonic relationship between leverage and hedging for high market-to-book value firms. The empirical findings are consistent with these predictions. The empirical study presents the first large-sample evidence on the extent of hedging by non-financial firms and provides many new findings. I find that large and small firms hedge for different reasons. While both groups hedge in response to the financial distress costs and exhibit economies of scale in hedging, large firms also hedge in response to underinvestment costs and tax-convexity, as predicted by the existing theories. 2 1

This paper uses U.S. Statistics of Income (SOI) Corporate Income TaxReturns balance sheet data on all corporations, to estimate the effects of changes in corporate tax rates on the debt policies of firms of different sizes. Small firms face very different tax rates than larger firms, and relative tax rates have also changed frequently over time, providing substantial information to identify tax effects. The results suggest that taxes have had a strong and statistically significant effect on debt levels. For example, cutting the corporate tax rate by ten percentage points (e.g. from 46 % to 36%), holding personal tax rates fixed, is forecast to reduce the fraction of assets financed with debt by around 3.5%. Since small firms normally rely much more heavily on debt finance yet face much lower tax incentives to use debt, the estimated effect of taxes would be strongly biased downwards without controls for firm size.