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Working Paper No. 841

Does the Debt Tax Shield Distort Ownership Efficiency?

Working Paper
Reference
Norbäck, Pehr-Johan, Lars Persson and Joacim Tåg (2010). “Does the Debt Tax Shield Distort Ownership Efficiency?”. IFN Working Paper No. 841. Stockholm: Research Institute of Industrial Economics (IFN).

Authors
Pehr-Johan Norbäck, Lars Persson, Joacim Tåg

The tax laws of most developed countries are debt biased since firms can deduct interest on debt but not on equity. This bias is known to distort investment decisions. However, less is known about how the debt tax shield affects the ownership of assets when bidders differ financial expertise and thus in optimal use of leverage. We show that the debt tax shield need not always distort ownership efficiency. Assets end up with the socially preferred owner when differences in financial and productive expertise between bidders is small and better financial expertise reduces expected bankruptcy costs.

Pehr-Johan Norbäck

+46 (0)8 665 4522
+46 (0)73 574 3379
pehr-johan.norback@ifn.se

Joacim Tåg

+46 (0)8 665 4524
joacim.tag@ifn.se