Environmental Protection Tax and Corporate Capital Structure

ABSTRACT

We utilize the environmental protection tax law as an exogenous shock to the tax of environmental protection to investigate the relationship between environmental issues and corporate capital structure. Our findings show that, following the adoption of this tax law, polluting firms are more likely to reduce their leverage. This phenomenon is more pronounced in polluting firms with excess cash, financially constrained firms, or financially distressed firms. Overall, we find that the environmental protection tax reduces corporate leverage by increasing corporate outlays and crowding out debt interest expenses.

KEYWORDS:

• Capital structure
• environmental protection tax
• corporate outlays

JEL:

• G32
• Q52

Acknowledgments

We appreciate helpful comments from the subject editor and an anonymous referee. Guangzhong Li acknowledges the financial support from the National Natural Science Foundation of China (71772190, U1811462).

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Supplementary Material

Supplemental data for this article can be accessed on the publisher’s website

Notes

1. From the view of the tax theory of capital structure, however, the EPT also could increase the debt ratio via increasing interest tax benefits. The trade-off theory argues that firms will trade-off between the tax benefits of debt and the financial distress costs of debt (Frank and Goyal 2009). When the new tax is imposed, firms have incentives to issue more debt to get the interest deduction (Graham 1996). Thus, the EPT could promote firms to issue more debt.

2. Classified management directory of environmental protection verification industry of listed companies: http://www.gov.cn/gzdt/2008-07/07/content_1038083.htm. It defines 16 high-polluting industries including thermal power, iron and steel, cement, electrolytic aluminum, coal, metallurgy, chemical, petrochemical, building materials, paper making, brewing, pharmaceutical, fermentation, textile, tanning, and mining.

3. In Section 5.1, we use multiple proxies of polluting firms for robustness.

4. In Section 5.3, we also cluster standard errors at the province level for robustness.

5. Section 5.1 presents the results.

6. We include additional controls in Section 5.2.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China [71772190,U1811462].