Dynamic Investment and Financing under PersonalTaxation

This paper examines the effects of capital gains taxation on firms’ investmentand financing decisions. We develop a real options model in which the timing ofinvestment, the decision to default, and the firm’s capital structure are endogenouslyand jointly determined. Our analysis demonstrates that the asymmetric taxation ofcapital gains and losses fosters investment by eroding the option value of waiting. Italso shows that firms controlled by taxable investors employ more equity financing,the higher the firm’s stock price and the worse the firm’s historical performance.[...]