Capital Structure, Corporate Investment, and Investor-Level Taxes: Evidence from a Natural Experiment in Europe

Abstract

We study a court ruling that materially affected dividend taxation in several European countries. The tax changes were not directly related to economic conditions or corporate financial policies, providing a useful experiment for studying the effect of taxation on capital structure, payout, and investment decisions. Consistent with theory, we find that dividends and equity issuance decline after these changes. Leverage ratios change little on average but increase substantially for capital-raising firms, which should be the most affected by the tax changes. Moreover, investment decreases, consistent with an increase in the after-tax cost of capital that arose from the tax change.