The Effects of Taxation on the Firm's Investment and Financial Behavior

The effects of taxation on the behavior of firms are examined in this paper. Earlier studies of this issue have concluded that, given certainty and true economic depreciation, corporate taxes have no effect on the firm's financial policy. External, e.g. legal, restrictions on the financial options of the firm have to be introduced in order for taxes to have such an effect. Our model turns these conditions around by taking the risk of bankruptcy into account. There then exists an interior financial optimum for the firm. The firm's investment decisions become inseparable from its financial decisions. Furthermore, changes in taxes on profit, personal income and capital gains induce the firm to make smooth adjustments in its optimal financial structure and optimal rate of investment.