Asymmetric Information, Capital and Ownership Structures and Corporate Income Taxation

This paper develops a signaling model to investigate a firm's optimal financial response to corporate income taxation under informational asymmetries. The model obtains informationally constrained efficient equilibria in which a firm's debt level and inside equity position jointly serve as a single separating signal. Separating equilibria are characterized differently depending upon the tax obligation and the relative profitability of a high-quality firm. When the quality difference between firms is relatively large, a high-quality firm shows a unique optimal capital structure, in which the debt-equity ratio is increased as the tax rate rises but is reduced as the firm's profitability increases.