Corporate Financing Policy and Taxation

Considerable debate centres around the use of debt finance as opposed to new equity and internally generated funds for the financing of new investment projects. The favourable corporate tax treatment of debt interest payments compared to equity returns appears to be a government incentive to debt finance. In addition, the differential tax treatment of financial institutions' income and individual investors' income under the tax code, all leads to the idea, that debt financing may increase the market value of a firm beyond the expected value of its operational cash flows.