Faulkender and Smith (2016) find firms operating in countries with higher tax rates tend to use more
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Question:
Faulkender and Smith (2016) find firms operating in countries with higher tax rates tend to use more debt. In years when tax are lower, firms are found to decrease leverage levels. Furthermore, they show firms in all countries borrow less than their borrowing capacity.
Requirement: Critically comment on these findings in relation to Modigliani- Miller (M&M) theory (with tax) by answering the following questions:
a) In what respect the above findings are consistent with the prediction of M&M (with tax) theory?
b) In what respect the findings are not consistent with the prediction of M&M theory (with tax) and what could be the reasons?
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