Debt and taxes for private firms

This paper analyzes the impact of marginal tax rates on the capital structure decision of private bank-financed firms. These firms are rarely studied in capital structure contexts and differ from large listed firms in terms of agency and asymmetric information problems and funding sources. It is argued that the solution to agency and asymmetric information problems for large firms shows up as restrictions on debt in the balance sheet, whereas for small firms these problems are solved by financial institutions and are therefore less apparent in the balance sheet. This makes it easier for small firms to exploit tax advantages of debt. Using a rich and unique data set of Portuguese firms, the empirical analysis finds that the marginal tax rate has an important impact on the capital structure of smaller private firms. It is also found that the balance sheet variables used for large listed firms in different countries to model agency costs and asymmetric information do not work well for smaller private firms. The only significant variables (besides tax variables) for small firms are bankruptcy (collateral) variables.