Thin Capitalization Rules and Entrepreneurial Capital Structure Decisions

Tax planners often choose debt over equity financing. As this has led to increased corporate debtfinancing, many countries have introduced thin capitalization rules to secure their tax revenues. In ageneral capital structure model we analyze if thin capitalization rules affect dividend and financingdecisions, and whether they can partially explain why corporations receive both debt and equitycapital. We model the Belgian, German and Italian rules as examples. We find that the so-called Millerequilibrium and definite financing effects depend significantly on the underlying tax system. Further,our results are useful for the treasury to decide what thin capitalization type to implement.