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The Impact Of Financial Constraints On The Relation Between Shareholder Taxes And The Cost Of Equity Capital

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Executive Summary

Using both the Tax Relief Act of 1997 (TRA) and the Jobs and Growth Tax Relief and Reconciliation Act of 2003 (JGTRRA), the authors conduct the first empirical investigation on how the tax cuts on dividends and/or capital gains affect the cost of equity differently for firms facing different degrees of financial constraints. They show that firms which have more pressing needs for capital and thus are more financially constrained experience larger reduction in the cost of equity when tax rates (capital gains tax and/or dividend tax) are reduced; non-dividend paying but financially constrained firms experience the largest cost of equity capital reduction when only capital gains tax rate is cut (TRA).

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