Debt and debt tax benefit: Evidence from Indonesia debt-to-equity cap reform

Abstract

This study scrutinizes the effects of Indonesia’s 2016 debt-to-equity cap reform (thin capitalization rule) on capital structure, highlighting the role of debt tax benefits. The reform curtails debt tax benefits and furnishes a quasi-experimental setting, allowing a comparison between firms affected by the reform and those unaffected. Focusing on private firms and employing an entropy balancing weighted difference-in-difference approach, we elucidate that the reform results in a substantial 9.7 percentage point reduction in the debt ratio and a 5.3 percentage point increase in the stock ratio. Additionally, utilizing a pseudo tax cut reform framework combined with an isolated impact of the zero marginal debt tax benefit, we identify an implied tax elasticity of debt around 0.88, contributing to the observed decline in the debt ratio. Notably, smaller firms exhibit a more pronounced response, and the stock ratio undergoes a significant metamorphosis, suggesting the need for nuanced policy adjustments. Overall, the study underscores the profound influence of debt tax benefits in shaping corporate financing decisions.