Personal taxes, endogenous default, and corporate bond yield spreads
Document Type
Article
Publication Date
6-1-2006
Abstract
Term structure models have often been criticized for failing to explain satisfactorily the yield spread between corporate and Treasury bonds. A potential problem is that the personal tax effect is ignored in these models. In this paper, we employ a structural model to investigate the role of personal taxes on both debt and equity returns in capital structure decisions and assess their impact on corporate bond yield spreads. It is shown that personal taxes affect the firm’s optimal capital structure, and the tax premium explains a substantial portion of yield spreads, especially for high-grade bonds. The predictive ability of the model for yield spreads is much improved when personal tax effects are accounted for. In controlling for the liquidity effect, we obtain implied personal income tax rates closely in line with Graham’s (1999) estimates.
Publication Title
Management Science
Recommended Citation
Liu, S. X.,
Qi, H.,
&
Wu, C.
(2006).
Personal taxes, endogenous default, and corporate bond yield spreads.
Management Science,
52(6), 939-954.
http://doi.org/10.1287/mnsc.1050.0497
Retrieved from: https://digitalcommons.mtu.edu/business-fp/24
Publisher's Statement
© 2006 Institute for Operations Research and Management Sciences. Publisher's version of record: http://dx.doi.org/10.1287/mnsc.1050.0497