The effect of tax regulation on firm value: the Turkish case of Allowance for Corporate Equity (ACE) regulation

ABSTRACT

Investors ex-ante price the tax shield that Turkish firms would enjoy and react positively to the introduction of a legislation that provides a deduction for new equity issues. Not all firms are equally affected by the equity tax shield. Cumulative abnormal returns prove significantly higher for levered firms who may find it easier to switch from debt to equity financing and for firms that have income to shield from tax. Furthermore, the most levered firms and the firms with the highest income, whom investors ex-ante expect to benefit most from the regulation, do indeed issue more equity to take advantage of the tax benefits of the new regulation.

KEYWORDS:

• Allowance for corporate equity
• tax shield for equity
• tax regulation
• event study

JEL CLASSIFICATION:

• G38
• H25
• K34

Disclosure statement

No potential conflict of interest was reported by the authors.

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

¹ Refer to Graham (2013), Feld et al. (2013) and Graham and Leary (2011) for excellent reviews on the literature that studies how taxes affect capital structure.

² Refer to IFS Capital Taxes Group (1991) and Isaac (1997) for discussion and viability of ACE regulation.

³ The newspaper account of discussions in The Grand National Assembly of Turkey is available at https://www.haberler.com/torba-kanun-teklifi-tbmm-plan-ve-butce-komisyonu-7082528-haberi/.

⁴ Interested readers may refer to http://www.resmigazete.gov.tr/eskiler/2015/04/20150407-19.htm for the full tax bill.

⁵ The tax bill demonstrates how the tax deduction for new equity issues will work with the following example. Assume Company XYZ issues additional equity of 1 TL as of 1 January 2016. Average loan interest rate (as determined by The Central Bank of the Republic of Turkey) is 13.57% as of 31 December 2016. Then, the equity tax deduction is as follows: Increase in equity x Loan interest rate x Time x Deduction rate = 1 TL x 13.57% x (12/12) x 50% = 0.06785 TL. The tax shield using the 20 percent corporate tax rate for a 1 TL increase in equity corresponds to 0.01357 TL in the year of the issue. Firms increasing cash capital benefit from the tax shield of 0.01357 TL not only in the year of issue but also in every year following the issue. Hence, the net present value of future tax shields arising from the 1 TL increase in equity (using the Central Bank’s loan interest rate of 13.57% and the perpetuity formula 0.01357/0.1357) will be 0.10 TL. In case of subsequent capital reductions, the reduced amount of capital is not taken into account in the tax shield calculation. Interested readers may refer to http://www.resmigazete.gov.tr/eskiler/2016/03/20160304-9.htm.

⁶ ACE regulation in Turkey offers a notional interest deduction (NID) from incremental cash capital against the effective interest cost deduction of debt. The aim is to address the debt bias in corporate sector. Refer to Zangari (2014) for the comparison of how Italy and Belgium practice ACE to eliminate the debt bias.

⁷ Refer to MacKinlay (1997) and Krivin et al. (2003) for excellent reviews on the literature for event study method and Basdas and Oran (2014) on event studies that focus on Turkey.

⁸ The specifics of the Chairperson’s televised statement are available at https://www.bloomberght.com/haberler/haber/1692619-spkertas-forexte-kayipkazanc-orani-yuzde-87.

⁹ We use the mean-adjusted model to calculate abnormal returns. Unreported results available upon request are robust to using other models such as the market model. We do not use the market model as our benchmark model since sample firms constitute 89% of the market index and we would be taking the average of abnormal returns coming from a weighted average of the sample returns.

¹⁰ Five-day CARs (2.88%) and seven-day CARs (2.62%) indicate qualitatively similar results.

¹¹ Statistical tests using Brown and Warner (1985) and Corrado (1989) prove similar.

¹² Market reaction differs according to industry. Abnormal returns in communications, consumer goods and utilities prove significant and returns in technology, real estate, basic materials, and conglomerate industries prove insignificant.

¹³ We also test market reaction for firms sorted according to their age and size (Beck et al. 2006; Farre-Mensa and Ljungqvist 2016). Abnormal returns in the three bins sorted according to age and size do not exhibit a clear difference in one direction. Results are available upon request.

¹⁴ We thank the anonymous referee for this suggestion. Refer to An (2012), Panier et al. (2015) and Clemente-Almendros and Sogorb-Mira (2016) for similar examples of difference-in-difference (DID) analysis.

¹⁵ For example, Afyon Cimento Sanayi issued 97 million TL cash equity as of 24 July 2015. The recognized equity tax deduction in 2015 and 2016 financial reports was 7.11 million and 16.45 million TL, respectively.