The Effect of Corporate Taxation On Firm Performance and Equity

THE EFFECT OF CORPORATE TAXATION ON FIRM
PERFORMANCE AND EQUITY

(Evidence from Non financial firms)
Abstract
The aim of the current study was to evaluate the effect of corporate taxes on the firm
performance and value in Pakistan Stock Exchange. The area of the study was non financial firms
listed at Pakistan Stock Exchange. At present there are 399 non financial firms as per the Balance
Sheet Analysis of non financial firms 2010-2015. These 399 firms were taken as the population of
the study. The sample is the unit which has been drawn from the population and having the same
features of population. It will be difficult to include all the listed non financial firms in the study.
By random sampling technique, the study takes 100 non financial firms as the sample of the study.
The study collected the non financial firms from 2010 to 2016. The variables of the current study
needs the data to be collected from the published reports i.e. the income statement and balance
sheet of the firm. The variables are quantitative in nature and their information can be downloaded
from the annual reports of the firm or from the report of State Bank of Pakistan i.e. Balance sheet
analysis of non financial firm. The data of the non financial firms will be collected from 2010 to
2016. The current study is based on the secondary data and in Pakistan Stock Exchange. The
findings argued that corporate taxation, firm size and growth have significant while dividend
payout rand leverage have insignificant effects on ROA while corporate taxation, dividend payout,
leverage and growth have significant while firm size has insignificant effect on firm value.
Keywords: Corporate taxes, dividend payout, ROA, firm value, regression etc
Introduction
Background of the study
The study of Income Tax ought to be of much significance since it features the present
condition regarding the organization profit based on which tax liabilities by the organization.
Taking a look the rates of Income Tax implemented in various business networks globally an aloft
pattern is obviously noticeable in all created and in couple of immature nations. In the study it is
inspected the effect of Income Tax on firm’s profitability and investment (Saeed, 2004).
Taxes are considered as a basic thing in the organization's money related articulations, it is
a critical part of each organization's execution. Right now tax evaluation is created in the way it is
a test for the organizations and for their sheets and Audit boards. The cooperation of sheets and
review boards of trustees fluctuates by nation and association, in that way their abnormal state
taxes methodologies make some more mistaken assumptions with respect to this imperative
perspective. They understand the organization dauntlessness for charge minimization against
impose confirmation. Organizations need to have an affirmation that the duty specialists won't
challenge their assessment position as it includes reputational hazard and punishment as well
(Mehran and Suher, 2009).
Managing complex evaluation tasks for worldwide, multinational companies spotlight

government laws and universal duty laws, actualize the innovative approaches to execute for
lessening worldwide tax collection, deciding the related tax dangers lastly secure organization's
tax positions. The concentration moved from exclusively planning and actualizing charge
structures to limiting worldwide salary charges while precisely representing them and the inside
controls encompassing this procedure, this move has not come simple for the present evaluation
administrators as Most duty officials see the issue as an "tax" issue that must be illuminated by
experienced, exceptionally talented duty experts and Tax Lawyers. In any case, when you inspect
the causal factors somewhat further, you find that it isn't so much an evaluation issue as it is an
"information" issue. To deliver exact, convenient and understandable worldwide wage impose
arrangements and required divulgences, each organization takes its worldwide budgetary
information, forms it as per the majority of its purview's duty principles and reports the results as
per its monetary announcing gauges. In this way, there are three potential regions where the issue
could emerge, information, impose standards and announcing rules and could conquer these issues
through above process (Louis et al., 2001).
Whether capital income should be taxed has long been debated among economists. Despite
the popularity of the corporate income tax with most governments, researchers have regularly
advocated the use of consumption or economic profit rather than income as a tax base. The fact
that the corporate income tax is not very popular among economists is due to several inefficiencies
it entails. For instance, the corporate tax structure is suspected to discourage the use of capital in
the corporate sector, to distort financing decisions, and to cause a preference for retaining profits
rather than distributing them.
Kaplow thus concludes that “(...) the corporate income tax, an important component of
many tax systems, is difficult to rationalize when taking an integrated view of the optimal taxation
problem.” (Kaplow, 2008, p. 238). In spite of these potential inefficiencies, most developed
economies, Germany included, traditionally have taxed corporate income. The main argument for
maintaining the tax on corporate income has to do largely with progressivity, since higherincome
individuals typically have a much larger share of their income from capital (Bach, Corneo, and
Steiner, 2009).
Arguing that individuals with capital endowment are supposed to make a larger
contribution to fiscal revenue, politicians hence employ capital taxation for redistribution. In recent
years, however, international tax competition has led to a continuous decline in tax rates. German
tax authorities, for instance, have reduced the statutory corporate tax rate on retained earnings from
45 percent in 1998 to 15 percent in 2008. As in several other countries which reduced statutory
corporate tax rates in recent decades, this has not resulted in a proportional decline in corporate
tax revenues. This “self-financing” effect indicates that part of tax rate reductions may be
compensated by higher economic activity or reduced income shifting and tax avoidance strategies
of the corporate sector.
Implying that the corporate tax base is elastic towards its tax rate, self-financing effects
also hint at a reduction in deadweight losses associated with taxation. In an influential pair of
papers, Feldstein (1995, 1999) showed that the overall excess burden of personal income taxation
can be calculated by estimating the effect of taxation on reported taxable income, i.e., the elasticity
of the income tax base. The approach is elegant because one does not have to account for the
various channels through which taxation might impact individual behavior (e.g., changes in effort,
capital input, financial structure, transfer pricing) to measure efficiency costs.1 However, while
Feldstein’s concept has been widely adopted in the literature on personal income taxation,
empirical estimates of the corporate tax base elasticity are still scarce. The present doctoral thesis
is the first microeconometric study based on taxation data providing evidence for whether firms
react to corporate income taxation.
However, while the tax base elasticity helps assessing the overall excess burden of
corporate income taxation, it does not reveal the firm decisions mostly affected by corporate
taxation. For this reason, I go one step further and specifically evaluate to what extend corporate
taxation distorts firms’ financial structure and capital formation, in each case relative to the levels
that would be chosen for nontax reasons. First, financial decisions might be influenced because
interest payments on debt lower a company’s profit liable for taxation while no similar deduction
exists for the interest yield on equity, i.e., the corporate income tax applies only to the yield on
corporate equity.2 Such differential taxation tends to encourage the use of debt rather than equity.
Despite extensive research effort, which is, as in all other chapters, reviewed in the chapter
itself, researchers have had great difficulty to provide empirical evidence on the elasticity of
financial leverage towards taxation. Second, because corporate income taxation generally
increases the user cost of capital, firms might also use a capital stock below the one they would
chose in a world without taxes. Beyond its influence on the long-term capital stock, taxation may
also affect investment dynamics. I thus assess whether dynamic models of investment provide an
empirically fruitful framework for analyzing tax effects on changes in capital stock.
The association amongst investment and financing is the focal issue when we concentrate
on corporate finance. In light of M & M theory, investment choice is isolated from finance
resources because of a progression of strict supposition. Modigliani and Miller (1958) contended
that the cost of capital is no changeable regardless of the leverage ratio is 0% or 100%. Hence the
NPV of upcoming future investment is the main variables that have impacts investment strategy.
Notwithstanding, the truth is not great. A lot of hypothetical and empirical works have tested the
M&M position, contending that a firm's investment strategy is leveraged by liquidity imperatives
and asymmetric information. Jensen and Meckling (1976) concluded that the firm with more debt
tends to over-investment. In actuality, Jensen (1986) got to the conclusion: the part of debt with
hard financial constraints will control the over investment. From an agency problem viewpoint,
Myer (1977) thought that exceedingly leverage firms may dismiss the positive NPV investments
because of irreconcilable circumstances amongst shareholders and banks. Gavish and Kalay
(1983), Green (1984) and Parrino and Weisbach (1999) came to an assention that too substantial
debts misshaped the investment exercises. Financing limit will diminish with leverage ratio
expanding. Without enough capital, the organizations will choose to contribute investments with
stable income every year regardless of the fact that these decisions are not the best ones. That is,
inadequate asset will prompt under-investment.
The effect of financial leverage on an company's investment choice is a focal issue in the
firm financial problems. Modigliani and Miller (1958) irrelevance suggestion is right, a firm's
investment arrangement ought to depend entirely on such elements as the future demand, the
association's updated technology of production, the business sector interest rate, that is, on strategic
determinants of profitability, income, and total assets. A huge hypothetical literature has tested
this position, contending that financing contemplations significantly complicate the investment
association, presenting essential determinants beyond neoclassical basics. In theory, finance tends
to leverage genuine investment decisions when there are lost or inadequate markets because of
transaction cost and information asymmetry that is, outside a MillerModigliani in a world with
incomplete markets, agency problems emerging from collaborations between shareholders,
creditors, and management offer ascent to underinvestment or overinvestment motivating forces;
these agency problems present an extent in which investment may not be completely responsive,
or may be over-responsive, to changes in financial basics.
Investment choices, as choices of strategic nature which start activity in the present to get
better the strategic position of the organization for years to come, must be subjected to risk analysis
that regularly on a very basic level changes the choice. Thusly, risk management turns into the
premise for decision making. Risk is inescapable until the size we don't comprehend what the
future brings. As a result, all management choices are the decision of the measure of the Risk taken
and methods for managing such risk. As needs be, the appraisal of Risk in the investment procedure
is a component of investment alternatives for the firm to decide. Uncertainty with respect to the
arrival of the undertaking decides the Risk of interest in significant projects which ought to be
tended to during the time spent settling on a investment choice. The level of Risk and profitability
of the investment decide its adequacy. Effect of Risk on the firm’s profitability is increased and
relies on upon the way of the investment. Leadership decision making under Risk is a decision
issue in which the manager is thinking about a few options and for each of these choices decides
probability. As far as Risk, leader has more data than in states of instability (Bojana and Kristina.
2011).
Recently, the empirical findings on capital structure and taxes have been to a great extent
leveraged by the equilibrium examination of Miller (1977). DeAngelo and Masulis (1980), for
instance, demonstrate that the presence of non-debt tax shields, for example, assets depreciation
deduction findings and investment tax credits, together with a asymmetric corporate expense code
that does not discount misfortunes, is adequate to topple the leverage insignificance suggestion of
Miller (1977), in any case, the DeAngelo-Masulis model predicts a negative relationship between
the level of investment related assessment shield substitutes for debt and the level of budgetary
leverage utilized by the firm. While the investigation might be seen as an incomplete
acknowledgment of the collaboration between the genuine and financial variables of the firm, it
misses the mark regarding completely joining the beneficial side of the economy since the
association's investment choices and non-debt tax shields are exogenous to the model.
Problem Statement
The income tax is the rules which has been implemented by the government on the income
generated from the personal or organization resources. The corporate income tax can play a
significant role in the nation’s economy as this is the source which can generate the revenue.
Different countries have different rate of income taxes charging on the firm or individual income.
In Pakistan, there are also the rules of income tax on the earning. The present study will evaluate
the role of corporate taxes in the firm profitability in non financial firms in Pakistan Stock
Exchange.
Objective
 To understand the role of corporate taxes on firm return on assets
 To check the role of corporate taxes in firm equity.
Literature Review
As per the study of Hines (1993) analyzed the impact of charges area and outside direct
speculation by looking at the between state circulation of ventures with remote interest in US.
Relapse utilized as a part of this examination, the outcomes showed that high tax rate inside the
state harms the nearby speculation; neighborhood speculator's proportion of offers in respect to
outside financial specialists is around 7 to 9 % for each 1 % rate of tax collection.
The study conducted by Rohra et.al, (2009) who examined the connection between taxes
framework factors and certain different factors of area basic leadership. These relations are tried
utilizing the information from money related specialist organizations working particularly in sindh
(Pakistan). The outcomes demonstrate that tax collection trouble (cost of consistence, assurance
of elucidation of tax laws, and exceptions/reasonings) are emphatically worried about the money
related administrations business area choices, or at the end of the day establishments are not
looking generally impose factor but rather they are just attempting to profit the Business openings.
The study conducted by De Mooij A.et.al, (Nov., 2001), demonstrated the effect of
organization the assignment of outside venture. Results of 25 experimental investigations similar
by registering the versatility in the firm tax rate. It is clarify this variety by the distinctions in
attributes of the basic investigations. Efficient contrasts between ponders are found as for the sort
of outside capital information utilized, and the kind of duty rates embraced. Regression is utilized
as a factual system. They found no deliberate contrasts in the responsiveness of financial specialists
from taxes credit nations and tax exception nations.
As per the study of Ahmed, (2004), demonstrates that operator firms abuse finish data
exemplified in arrangements of evaluation the tax strategy. The examination has been identified
with the effect of Tax liabilities on various factors of gross benefit, cost of offers, costs and so on.
An example of 7,306 organizations from the lodgings and eateries area, incorporates 6,594 in
business administrations and 1,484 in transport producing divisions, for the bookkeeping time
frames 1995 to 2000. He discovered ramifications for smaller scale reenactment demonstrating,
money related straightforwardness, and corporate administration.
According to Nnadi, (2008) investigates the effect of taxes on the profit. The investigation
distinguished example of past profits, worry about keeping up an objective capital structure, ebb
and flow level of monetary use, investor requirements for profit salary, legitimate standards and
imperatives; enlightening measurements technique has been utilized as a part of this exploration,
they found a critical relationship amongst's charges and profit and furthermore propose that benefit
is a noteworthy development of profit strategy of the associations.
According to study of Salinger and Lawrence (1981) investigate the impact of Taxes on
singular company's speculation and securities exchange valuation. Information were gathered US
organizations, Q hypothesis of speculation approach is utilized as a part of this paper to break
down impacts of duty changes and the adjustments. Research discoveries in this examination are
an tax changes great impact which varies in various firms.
As per the study conducted by Fazzari et al., (1987) explore market imperfection for
liabilities and equity as a few organizations don't have the entrance to the outside and unfit to
respond as per the adjustments in resource equity or evaluation, the analyst inspect the financing
progressive system in which the inward back has essential money saving advantages over the outer
fund. By utilizing board information of assembling organizations they found that q esteems were
stay high for vast day and age the profit by the organizations, in respect firms. They finish up
venture is considerably more responsive to the income for those gathering of outer back
restrictions.
As per the findings taken from the study of Rajan et.al, (1998) dissected how much income
accessibility and Firm Size effect Capital inside Investment in OECD Countries. In particular,
study intends to look at on a very basic level inside resources (Capital Investment). Little firms
have compelled excess to outside Capital markets. Each one of the associations have been
investigated, paying little personality to quantify in Each Country. The result revelations show that
Firm Size and Cash stream has useful results and uncommonly sensitive association with inward
premiums in each one of the countries. Help more, it has moreover wander have broad affectability
customarily in Largest firm size social affair and little in the tiniest firm size get-together. Since
the explanation behind this investigation is to can't avoid being to find the effect of Tax on firm
on hypothesis and besides to find to what grow Tax and firm assets the wander and make full use
of it with the point of view of making estimation of firms of nine one of a kind divisions in Pakistan.
Thusly, there are obliged composing on relationship of corporate wage charge, firm size and
wander decided for taking a gander at their effect on organizations of non cash related firms. This
examination is maintained by couple of researchers, which suggest that recognizing verification
of powerful wellspring of financing for wander is essential. In addition firm size can construct the
measure of wander yet augment in corporate pay force extent in an industry's specific territory
generally anyway not seldom reveals diminish in theory which may impact the enthusiasm for
various Listed Manufacturing and organization organizations.
The theoretical relation between corporate leverage and stock returns is one of the most
fundamental issues in finance, and, understandably, well taught in finance courses at all levels. It
provides the basis for understanding important issues such as cost of equity and corporate bond
pricing. By stark contrast, few people know the empirical relation between leverage and stock
returns. The empirical findings are conflicting and at best inconclusive. Half a century after
Modigliani and Miller (1958), financial economists are still searching for answers for the following
first-order questions: what exactly is the empirical relation between leverage and stock returns,
and why? In particular, we examine whether stock returns are related to different leverage ratio
measures including total leverage, short-term debt leverage, long-term debt leverage, short term
debt issuance, and long-term debt issuance. We find that higher stock returns are related to
significantly higher short-term debt leverage, but to lower long-term debt leverage and
significantly lower long-term debt issuance. In other words, the relation between stock returns and
leverage goes in opposite directions depending on debt maturity. As a result, there is no relation
between stock returns and total leverage.
The positive (negative) relation between stock returns and short-term leverage (long-term
debt issuance) is significant. An annual sorting of ten portfolios based on short-term leverage
(long-term debt issuance) generates a monthly spread of 0.78% (-0.49%). These spreads are large
compared to the well-known value spread of around 0.5% per month and the size spread of around
0.2% per month. They are also robust to the well-known risk factors. For example, the return
spread of short-term debt leverage remains significant at 0.70% after controlling for CAPM, 0.63%
after controlling for the Fama-French three-factor model, and 0.48% after controlling for the four-
factor Carhart model.
Why are stock returns related to leverage ratios? To understand this issue, we first conduct
a double sorting of leverage measures and size. Interestingly, we find that the significant positive
relation between stock returns and short-term leverage only exists among large firms. In contrast,
the significant negative relation between stock returns and long-term debt issuance only exists
among small and medium sized firms, but not among large firms. Therefore, even after controlling
for size, stock returns are related to leverage (conditional on maturity) among a big chunk of firms.
Since having high leverage can make firms financially more constrained, we next explore whether
financial constraints can explain the stock return-leverage relations. Following the current
literature (e.g., Kaplan and Zingalas (1997) and Lamont et al. (2001)), we adopt various financial
constraint measures; we find no clear relation between these measures and either short-term debt
leverage or long-term debt issuance. Therefore, it seems that financial constraints might not
explain the stock return-leverage relations.
Are there theories in the current literature that can explain the conditional relation between
stock returns and leverage? We find that firms with higher short-term debt invest less, and firms
with higher long-term debt issuance invest more. Investment-based models (e.g., Chen, Novy-
Marx, and Zhang (2010)) predict that firms that invest a lot should have lower expected returns.
Indeed, the Chen, Novy-Marx, and Zhang three-factor model can completely explain the
conditional relation between stock returns and leverage across maturity. Therefore, the investment-
based interpretation works. The limitation of this interpretation is that we still do not understand
why certain firms invest more than others; nor do we know why investment decisions are related
to debt maturity.
The empirical literature on the relation between leverage and stock returns is extensive, but
inconclusive. A large number of studies try different definitions of expected returns to see if there
is any empirical relation between leverage and equity risk. For example, Arditti (1967) finds a
negative but statistically insignificant association between leverage and equity returns, which are
taken as the geometric mean of returns. Hall et al (1967) uses another definition. Returns are taken
to be profits after tax and the ratio of book value of equity to assets are used to measure leverage.
He finds leverage has a negative relation with returns. Hamada (1972) defines returns as profits
after taxes and interest which is the earnings the shareholders receive on their investments. He uses
industry as a proxy for business risk. Bhandari (1988) gets inflation adjusted stock returns for all
firms including financials. He uses the cross section of all firms without assuming different risk
classes. He shows returns increase with leverage.
Different definitions for leverage are also implemented to understand the leverage-stock
returns relation in the literature. Baker (1973) calculates financial leverage by taking the ratio of
equity to total assets for the leading firms in an industry over one year. He shows that at the industry
level, leverage raises industry profitability and higher leverage implies greater risks. Korteweg
(2004) finds a negative association between stock returns and leverage based on pure capital
structure changes such as exchange offers. Dimitrov and Jain (2005) report a negative relation
between leverage and stock returns by studying changes in leverage and show that they are
negatively related to current and future returns. They calculate returns as risk adjusted raw returns.
They differentiate between borrowing for operations or for growth to examine the effect of
leverage due to economic performance and not due to growth, mergers and acquisitions and other
reasons. George et al (2006) find a negative relation between returns and leverage. They use book
leverage in their tests.
They argue that firms, which get affected more adversely in financial distress, have lower
leverage. Penman et al (2007) investigate the book-to-price effect in expected stock returns and its
relation to leverage. They divide the book to price value into an enterprise and a leverage
component. These stand for the operational risk and financial risk. They show that the leverage
component is negatively related to expected stock returns.
There is very little research that offers theoretical explanations to above empirical findings
and proposes future empirical studies on the relation between leverage and equity risk. After the
seminal work of Modigliani and Miller (1958), the most substantial theory on this subject is built
by Gomes and Schmid (2010). In the former of these two studies, leverage is taken to be exogenous
and the financial risk of leverage on firm’s equity is noted under the assumption that there is no
arbitrage in the market. In the latter study, it is recognized that leverage is endogenous and there
can be a negative relation between expected stock returns and leverage since firms that have higher
leverage also invest more. Through investment, these firms may exhaust their growth options,
turning them into assets in place and making their total assets less risky. Hence, firms with higher
leverage can have lower cost of equity.
Despite the extensive empirical literature on the relation between leverage and stock
returns, there is no study examining the effect of short term or long term debt on returns. This is
quite important since short term debt and long term debt are fundamentally different and they are
used for different purposes, which have implications on cost of equity.
Investment is known to be related to cost of equity (e.g., Chen, Novy-Marx, and Zhang
(2010)). Firms that invest more have lower cost of equity, on average. Loan maturities vary with
the types of assets that are being financed. As Hart and Moore(1998) observe, assets tend to be
matched with liabilities. Long term debt is often used to finance fixed assets (property, machinery,
land etc.), while short term debt tends to be used for working capital purposes (mitigating seasonal
imbalances, payroll, inventories etc.). In this sense, firms that invest more usually do it with longer
maturity of debt.
Maturity of debt is also important for the cost of debt and hence capital structure decision
of the firm. Bankruptcy is directly related to current debt situation, in other words, to short term
debt. This is relevant since interest rates on debt are lower if bankruptcy costs are higher (Leland,
1994). Long term debt is affected by the existence or lack of collateral assets but short term debt
is not (Pindalo, Rodriguez and de la Torre, 2006). Short term debt is also useful to banks in terms
of collecting their loans back quickly in the case of bad performance of borrowers. For the
entrepreneur, short term debt is better because it is cheaper. Thus, both entrepreneur and bank
prefers short-term debt (Landier and Thesmar, 2009).
Size
The size effect in the cross-section of stock returns is one of the most extensively studied
topics in financial economics. It was widely accepted that small firms earn higher returns than big
firms until the mysterious disappearance of the size effect in the early 1980s. Our paper examines
the hypothesis that differences across firms in unexpected returns that arise from in sample
profitability shocks are responsible for the disappearance of the size effect. To investigate this
hypothesis, we estimate the profitability shocks to individual firms using a cross-sectional
profitability model. We show that profitability shocks are close to zero for small and big firms
over 1963-1983, but there is a clear positive relation between profitability shocks and firm size
after 1984. Small firms on average experience substantial negative shocks to their profitability,
while big firms experience positive shocks. After adjusting for the price impact of profitability
shocks, we uncover a significant size premium of around 10% per annum for 1984-2005. The
resurrection of the size effect for post-1984 period is robust to alternative profitability models,
different return adjustments, and different test methods.
The relationship between firm size and profitability occupy a substantial portion of
economic literature. However, previous empirical investigations of the issue have yield conflicting
results. Some studies have obtained a weak or negative relationship or none at all (Shepherd 1972;
Ammar et al. 2003); others have reported a positive association (Punnose, 2008; Vijayakumar and
Tamizhselvan, 2010). Still others have found a positive association that disappear or reverses itself
among the firms with the largest assets. Besides the conflicting results on the relationship between
firm size and profitability, almost all known existing studies have focused on the impact of the
former on the latter neglecting the possibility of feedback. However, it is possible for profitability
to affect fir size and vice versa. It is contended in the literature that the profit rates of the firms can
persist over time and increasing levels of profits can help firm grow faster and at the same time
the size of a firm plays an important role in determining the kind of relationship the firm enjoys
within and outside its operating environment. The larger a firm is, the greater the influence it has
on its stakeholders. Again, the growing influences of conglomerates and multinational
corporations in today’s global economy (and in local economies where they operate) are indicative
of what role size plays within the corporate environment.
In another study, Serrasqueiro and Nunes (2008) investigated the relationship between firm
size and performance of small and medium sized Portuguese companies for the period 1999 to
2003. Their results indicate that there is a positive and statistically significant relationship between
size and profitability of SMEs. On the other hand, for the large Portuguese companies, they found
a statistically insignificant relationship between size and profitability (Serrasqueiro et al, 2008).
More recently, Lee (2009) analyzed the effects of size on profitability for over 7.000 US publicly-
held firms during the period 1987-2006 and he found that firm size has positive impacts on
profitability (Lee, 2009). After the above review, it is possible to say that the results of the
empirical studies on the effects of size on profitability are far from being unequivocal. Yet, some
studies find a positive impact, while others find negative or no relationship between firm size and
profitability.
But, overall, tax differential effects on internal leverage seems to be almost as large
as tax rate effects indicating that shifting of debt is a relevant strategy for MNEs. Note that the
papers in the fifth category of Table 1 provide the most direct empirical identification of debt
shifting by analyzing the impact of tax differentials on intercompany loans. However, the datasets
of these papers (MiDi database of the German Bundesbank) include either German MNEs and
their foreign subsidiaries or German subsidiaries of foreign MNEs, which limits the transferability
of the quantitative results to other countries.
Although most studies use micro-level panel data, the papers deviate in almost all other
dimensions: the ownership share threshold to define a firm as an affiliate of the group, the country
coverage, the calculation of tax rates (additionally accounting for dividend taxes, withholding
taxes, depreciation allowances and/or the international tax system) and tax differentials (difference
to the parent and/or to other affiliates, unweighted or weighted), and the estimation method
(affiliate vs. group fixed effects, set of control variables). Therefore, a comparison of different tax
effects in the empirical literature has to be taken with care.
Different concepts of future oriented effective taxes rate have been introduced to provide
information on the effective tax burden of investments, industries and sectors. All effects arising
from the tax rate, tax base components and tax timing effects are condensed in one measure, the
effective tax rate. We can distinguish between effective tax rates for marginal investment projects
(effective marginal tax rates) and effective tax rates for projects irrespective of the underlying net
present value, thus including inframarginal projects (effective average tax rates). Based on
neoclassical investment theory and the concept of user cost of capital (e.g. Hall/Jorgenson (1967))
marginal and average effective tax rates have been deduced (cf. e.g., Fullerton (1984); Spooner
(1986)). The seminal contribution by King and Fullerton (1984) is a standard model of marginal
effective tax rates. They analyze marginal effective tax rates for various countries and model the
effective marginal tax rate (EMTR) as a relative tax-induced change in the rate of return of a
fictitious investment project with a pre-tax net present value of zero. Devereux und Griffith (1998,
1999, 2003) expand this model in a oneperiod setting with respect to inframarginal investment
projects with an identical pre-tax rate of return and determine the effective average tax rate (EATR)
(cf. Schreiber/Spengel/Lammersen (2002)). Since a constant yardstick for measuring the effects
of taxation on inframarginal investment projects has not been integrated into EATR models,
Knirsch (2007) generalizes the concept of EATR with reference to an investment neutral tax base.
Whereas in case of EMTR the nominal tax rate serves as a yardstick, with inframarginal projects
we need a yardstick that is independent of the project’s pre-tax rate of return (cf. Knirsch (2007)).
The resulting neutrality-based effective tax rate is a multi-period approach that succeeds in
quantifying the tax burden from inframarginal investment projects.
Effective tax measures aside, the group tax rate has been an issue in theoretical and
empirical research on the determinants and the level of corporate tax burdens. Theoretical analyses
have been provided by e.g. Robinson/Sansing (2008). Furthermore, Zimmermann (1983)
investigates the group tax rate empirically referring to data on 50 US companies from 1970 to
1981. He finds a significant positive correlation between company size and group tax rate. Kern
and Morris (1992) expand this study with respect to industry effects and acknowledge his results.
Empirical investigations by Porcano (1986) and Gupta/Newberry (1997) find evidence of a
negative correlation, Stickney/McGee (1982), Shevlin/Porter (1992) and Janssen (2003) are unable
to identify a correlation (cf. also European Commission (2005) and the cross-country industry
specific studies by PricewaterhouseCoopers (2004)). Baumann/Schadewald (2001) investigate the
impact of foreign operations on reported effective tax rates.
Buijink/Janssen/Schols (2002) use the difference between the group tax rate and the
statutory tax rate as a measure for government tax incentives. The results help to explain why
group tax rates of companies within the same industry but of different geographic origin vary.
Swenson (1999) conjectures that the stock market views low-tax firms as being better at
controlling costs than their high-tax industry peers. Collins/Shackelford (1995) use the effective
group tax rate in order to determine the marginal impact of a company’s domicile on its worldwide
tax burden. Dhaliwal/Gleason/Mills (2004) and Cook/Huston/Omer (2008) examine whether firms
manage their earnings through changes in their effective tax rates between the third and fourth
quarter. Bauman/Shaw (2005) view the forecasted annual effective tax rate as a source of private
information and assess its usefulness in predicting future quarterly earnings.
Introduction
The theoretical relation between corporate leverage and dividend payouts is one of the most
fundamental issues in finance, and, understandably, well taught in finance courses at all levels. It
provides the basis for understanding important issues such as cost of equity and corporate bond
pricing. By stark contrast, few people know the empirical relation between leverage and dividend
payouts. The empirical findings are conflicting and at best inconclusive. Half a century after
Modigliani and Miller (1958), financial economists are still searching for answers for the following
first-order questions: what exactly is the empirical relation between leverage and dividend payouts,
and why? In particular, we examine whether dividend payouts are related to different leverage
ratio measures including total leverage, short-term debt leverage, long-term debt leverage, short
term debt issuance, and long-term debt issuance. We find that higher dividend payouts are related
to significantly higher short-term debt leverage, but to lower long-term debt leverage and
significantly lower long-term debt issuance. In other words, the relation between dividend payouts
and leverage goes in opposite directions depending on debt maturity. As a result, there is no
relation between dividend payouts and total leverage.
The positive (negative) relation between dividend payouts and short-term leverage (long-
term debt issuance) is significant. An annual sorting of ten portfolios based on short-term leverage
(long-term debt issuance) generates a monthly spread of 0.78% (-0.49%). These spreads are large
compared to the well-known value spread of around 0.5% per month and the size spread of around
0.2% per month. They are also robust to the well-known risk factors. For example, the return
spread of short-term debt leverage remains significant at 0.70% after controlling for CAPM, 0.63%
after controlling for the Fama-French three-factor model, and 0.48% after controlling for the four-
factor Carhart model.
Why are dividend payouts related to leverage ratios? To understand this issue, we first
conduct a double sorting of leverage measures and size. Interestingly, we find that the significant
positive relation between dividend payouts and short-term leverage only exists among large firms.
In contrast, the significant negative relation between dividend payouts and long-term debt issuance
only exists among small and medium sized firms, but not among large firms. Therefore, even after
controlling for size, dividend payouts are related to leverage (conditional on maturity) among a
big chunk of firms. Since having high leverage can make firms financially more constrained, we
next explore whether financial constraints can explain the dividend payout-leverage relations.
Following the current literature (e.g., Kaplan and Zingalas (1997) and Lamont et al. (2001)), we
adopt various financial constraint measures; we find no clear relation between these measures and
either short-term debt leverage or long-term debt issuance. Therefore, it seems that financial
constraints might not explain the dividend payout-leverage relations.
Are there theories in the current literature that can explain the conditional relation between
dividend payouts and leverage? We find that firms with higher short-term debt invest less, and
firms with higher long-term debt issuance invest more. Investment-based models (e.g., Chen,
Novy-Marx, and Zhang (2010)) predict that firms that invest a lot should have lower expected
returns. Indeed, the Chen, Novy-Marx, and Zhang three-factor model can completely explain the
conditional relation between dividend payouts and leverage across maturity. Therefore, the
investment-based interpretation works. The limitation of this interpretation is that we still do not
understand why certain firms invest more than others; nor do we know why investment decisions
are related to debt maturity.
The empirical literature on the relation between leverage and dividend payouts is extensive,
but inconclusive. A large number of studies try different definitions of expected returns to see if
there is any empirical relation between leverage and equity risk. For example, Arditti (1967) finds
a negative but statistically insignificant association between leverage and equity returns, which are
taken as the geometric mean of returns. Hall et al (1967) uses another definition. Returns are taken
to be profits after tax and the ratio of book value of equity to assets are used to measure leverage.
He finds leverage has a negative relation with returns. Hamada (1972) defines returns as profits
after taxes and interest which is the earnings the shareholders receive on their investments. He uses
industry as a proxy for business risk. Bhandari (1988) gets inflation adjusted dividend payouts for
all firms including financials. He uses the cross section of all firms without assuming different risk
classes. He shows returns increase with leverage.
Different definitions for leverage are also implemented to understand the leverage-
dividend payouts relation in the literature. Baker (1973) calculates financial leverage by taking the
ratio of equity to total assets for the leading firms in an industry over one year. He shows that at
the industry level, leverage raises industry profitability and higher leverage implies greater risks.
Korteweg (2004) finds a negative association between dividend payouts and leverage based on
pure capital structure changes such as exchange offers. Dimitrov and Jain (2005) report a negative
relation between leverage and dividend payouts by studying changes in leverage and show that
they are negatively related to current and future returns. They calculate returns as risk adjusted raw
returns. They differentiate between borrowing for operations or for growth to examine the effect
of leverage due to economic performance and not due to growth, mergers and acquisitions and
other reasons. George et al (2006) find a negative relation between returns and leverage. They use
book leverage in their tests.
They argue that firms, which get affected more adversely in financial distress, have lower
leverage. Penman et al (2007) investigate the book-to-price effect in expected dividend payouts
and its relation to leverage. They divide the book to price value into an enterprise and a leverage
component. These stand for the operational risk and financial risk. They show that the leverage
component is negatively related to expected dividend payouts.
There is very little research that offers theoretical explanations to above empirical findings
and proposes future empirical studies on the relation between leverage and equity risk. After the
seminal work of Modigliani and Miller (1958), the most substantial theory on this subject is built
by Gomes and Schmid (2010). In the former of these two studies, leverage is taken to be exogenous
and the financial risk of leverage on firm’s equity is noted under the assumption that there is no
arbitrage in the market. In the latter study, it is recognized that leverage is endogenous and there
can be a negative relation between expected dividend payouts and leverage since firms that have
higher leverage also invest more. Through investment, these firms may exhaust their growth
options, turning them into assets in place and making their total assets less risky. Hence, firms with
higher leverage can have lower cost of equity.
Despite the extensive empirical literature on the relation between leverage and dividend
payouts, there is no study examining the effect of short term or long term debt on returns. This is
quite important since short term debt and long term debt are fundamentally different and they are
used for different purposes, which have implications on cost of equity.
Investment is known to be related to cost of equity (e.g., Chen, Novy-Marx, and Zhang
(2010)). Firms that invest more have lower cost of equity, on average. Loan maturities vary with
the types of assets that are being financed. As Hart and Moore(1998) observe, assets tend to be
matched with liabilities. Long term debt is often used to finance fixed assets (property, machinery,
land etc.), while short term debt tends to be used for working capital purposes (mitigating seasonal
imbalances, payroll, inventories etc.). In this sense, firms that invest more usually do it with longer
maturity of debt.
Maturity of debt is also important for the cost of debt and hence capital structure decision
of the firm. Bankruptcy is directly related to current debt situation, in other words, to short term
debt. This is relevant since interest rates on debt are lower if bankruptcy costs are higher (Leland,
1994). Long term debt is affected by the existence or lack of collateral assets but short term debt
is not (Pindalo, Rodriguez and de la Torre, 2006). Short term debt is also useful to banks in terms
of collecting their loans back quickly in the case of bad performance of borrowers. For the
entrepreneur, short term debt is better because it is cheaper. Thus, both entrepreneur and bank
prefers short-term debt (Landier and Thesmar, 2009).
The size effect in the cross-section of dividend payouts is one of the most extensively
studied topics in financial economics. It was widely accepted that small firms earn higher returns
than big firms until the mysterious disappearance of the size effect in the early 1980s. Our paper
examines the hypothesis that differences across firms in unexpected returns that arise from in
sample profitability shocks are responsible for the disappearance of the size effect. To investigate
this hypothesis, we estimate the profitability shocks to individual firms using a cross-sectional
profitability model. We show that profitability shocks are close to zero for small and big firms
over 1963-1983, but there is a clear positive relation between profitability shocks and firm size
after 1984. Small firms on average experience substantial negative shocks to their profitability,
while big firms experience positive shocks. After adjusting for the price impact of profitability
shocks, we uncover a significant size premium of around 10% per annum for 1984-2005. The
resurrection of the size effect for post-1984 period is robust to alternative profitability models,
different return adjustments, and different test methods.
The relationship between firm size and profitability occupy a substantial portion of
economic literature. However, previous empirical investigations of the issue have yield conflicting
results. Some studies have obtained a weak or negative relationship or none at all (Shepherd 1972;
Ammar et al. 2003); others have reported a positive association (Punnose, 2008; Vijayakumar and
Tamizhselvan, 2010). Still others have found a positive association that disappear or reverses itself
among the firms with the largest assets. Besides the conflicting results on the relationship between
firm size and profitability, almost all known existing studies have focused on the impact of the
former on the latter neglecting the possibility of feedback. However, it is possible for profitability
to affect fir size and vice versa. It is contended in the literature that the profit rates of the firms can
persist over time and increasing levels of profits can help firm grow faster and at the same time
the size of a firm plays an important role in determining the kind of relationship the firm enjoys
within and outside its operating environment. The larger a firm is, the greater the influence it has
on its stakeholders. Again, the growing influences of conglomerates and multinational
corporations in today’s global economy (and in local economies where they operate) are indicative
of what role size plays within the corporate environment.
In another study, Serrasqueiro and Nunes (2008) investigated the relationship between firm
size and performance of small and medium sized Portuguese companies for the period 1999 to
2003. Their results indicate that there is a positive and statistically significant relationship between
size and profitability of SMEs. On the other hand, for the large Portuguese companies, they found
a statistically insignificant relationship between size and profitability (Serrasqueiro et al, 2008).
More recently, Lee (2009) analyzed the effects of size on profitability for over 7.000 US publicly-
held firms during the period 1987-2006 and he found that firm size has positive impacts on
profitability (Lee, 2009). After the above review, it is possible to say that the results of the
empirical studies on the effects of size on profitability are far from being unequivocal. Yet, some
studies find a positive impact, while others find negative or no relationship between firm size and
profitability.
But, overall, tax differential effects on internal leverage seems to be almost as large
as tax rate effects indicating that shifting of debt is a relevant strategy for MNEs. Note that the
papers in the fifth category of Table 1 provide the most direct empirical identification of debt
shifting by analyzing the impact of tax differentials on intercompany loans. However, the datasets
of these papers (MiDi database of the German Bundesbank) include either German MNEs and
their foreign subsidiaries or German subsidiaries of foreign MNEs, which limits the transferability
of the quantitative results to other countries.
Although most studies use micro-level panel data, the papers deviate in almost all other
dimensions: the ownership share threshold to define a firm as an affiliate of the group, the country
coverage, the calculation of tax rates (additionally accounting for dividend taxes, withholding
taxes, depreciation allowances and/or the international tax system) and tax differentials (difference
to the parent and/or to other affiliates, unweighted or weighted), and the estimation method
(affiliate vs. group fixed effects, set of control variables). Therefore, a comparison of different tax
effects in the empirical literature has to be taken with care.
(1986)). The seminal contribution by King and Fullerton (1984) is a standard model of marginal
effective tax rates. They analyze marginal effective tax rates for various countries and model the
effective marginal tax rate (EMTR) as a relative tax-induced change in the rate of return of a
fictitious investment project with a pre-tax net present value of zero. Devereux und Griffith (1998,
1999, 2003) expand this model in a oneperiod setting with respect to inframarginal investment
projects with an identical pre-tax rate of return and determine the effective average tax rate (EATR)
(cf. Schreiber/Spengel/Lammersen (2002)). Since a constant yardstick for measuring the effects
of taxation on inframarginal investment projects has not been integrated into EATR models,
Knirsch (2007) generalizes the concept of EATR with reference to an investment neutral tax base.
Whereas in case of EMTR the nominal tax rate serves as a yardstick, with inframarginal projects
we need a yardstick that is independent of the project’s pre-tax rate of return (cf. Knirsch (2007)).
The resulting neutrality-based effective tax rate is a multi-period approach that succeeds in
quantifying the tax burden from inframarginal investment projects.
Research Methodology
Population
The aim of the current study will be to evaluate the effect of corporate taxes on the firm
performance and equity in Pakistan Stock Exchange. The area of the study will be the non financial
firms listed at Pakistan Stock Exchange. At present there are 399 non financial firms as per the
Balance Sheet Analysis of non financial firms 2010-2015. These 399 firms will be taken as the
population of the study.
Sample Size
The sample is the unit which has been drawn from the population and having the same
When the population of the study is homogenous then the study can use the random sampling
technique (Ahmed, 2004). By random sampling technique, the study will take 100 non financial
firms as the sample of the study. The study will collected the non financial firms from 2010 to
2016.
K = N/n
= 397/100 4 (every 4th firm will be included in the study)
Data Collection
The variables of the current study needs the data to be collected from the published reports
i.e. the income statement and balance sheet of the firm. The variables are quantitative in nature
and their information can be downloaded from the annual reports of the firm or from the report of
State Bank of Pakistan i.e. Balance sheet analysis of non financial firm. The data of the non
financial firms will be collected from 2010 to 2016.
Data Analysis
The current study is based on the secondary data and in Pakistan Stock Exchange. The
nature of the study is both time series and cross sectional in nature which makes it panel data. The
data of the variables will be collected from the sources, then it is will imported to MS Excel and
then the Excel sheet will be imported to Stata v 12. Then the recommend models will be run on
the data.
Hypotheses
H0: Corporate tax rate has negative effect on ROA
H1: Corporate tax rate has positive effect on ROA
H0: Firm leverage rate has negative effect on ROA
H1.2: Firm leverage rate has positive effect on ROA
H0: Firm size rate has negative effect on ROA
H1.3: Firm size rate has positive effect on ROA
H0: Firm growth has negative effect on ROA
H1.4: Firm growth has positive effect on ROA
H0: Firm dividend payout has negative effect on ROA
H1.5: Firm dividend payout has positive effect on ROA
H0: Corporate tax rate has negative effect on the firm equity
H2: Corporate tax rate has positive effect on the firm equity
H0: Firm leverage rate has negative effect on the firm equity
H2.1: Firm leverage rate has positive effect on the firm equity
H0: Firm size rate has negative effect on the firm equity
H2.2: Firm size rate has positive effect on the firm equity
H0: Firm growth has negative effect on the firm equity

H2.3: Firm growth has positive effect on the firm equity
H0: Firm dividend payout has negative effect on the firm equity
H2.4: Firm dividend payout has positive effect on the firm equity
Variables & Measurement
Dependent
Firm Performance
The effect of firm performance can lead to alter the country taxation have been extensively
researched in the literature of corporate finance. Return on assets can be taken as the best proxy to
estimate the firm performance (Martin and Sayrak, 2003). The return on assets (ROA) will be taken
as the proxy to measure the performance of the firm. It will be calculated as:
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
ROA =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Firm equity
Tobin’s Q
The firm equity as the dependent variable of the study. The Tobin’s Q was selected as the
proxy for the measurement of firm performance. The firm performance will be measured by:
𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

QR =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
Independent
Corporate Taxation
The corporate taxation will be the dependent variable of the study. The study will evaluate
the effect of corporate taxation on the firm performance and their equity. The corporate taxation
will be measured by:
𝑇𝑎𝑥 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
CR =
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
Dividend Payout ratio

The dividend payout ratio is the independent variable of the study. The dividend payout
ratio is taken as the proxy for the investor protection of non financial firms. The dividend payout
ratio is measured by total dividend to net income of the firm (Khan and Jain, 2007).
Total Dividend
DPR =
Net Income
Leverage
The leverage is the control variable of the study. The leverage is taken as the proxy for the
capital structure of non financial firms. The leverage is measured by total debts to total equity
(Khan and Jain, 2007).
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡𝑠
LEV =
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
Growth
The sales growth is the control variable of the study. The sales growth is taken as the proxy
for the getting growth by the non financial firms. The sales growth is measured by the variance of
current year sale to the previous year sale (Shah, 2011).
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑆𝑎𝑙𝑒
Sales growth = ln (
𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑆𝑎𝑙𝑒
)
Firm Size
The firm size is the control variable of the study. The firm size is taken as the proxy for the
getting higher total assets by the non financial firms. The firm size is measured by the log of firm
total assets (Shah, 2011).
FS = Log (𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠)

Model
ROA = α + β0 + β1(CRT) + β2(DP) + β3 (LEV)+ β4 (FZ)+ β5 (GR)+ e (1)

QR = α + β0 + β1(CRT) + β2(DP) + β3 (LEV)+ β4 (FZ)+ β5 (GR)+ e (2)
Where
ROA = Return on assets
QR = Firm equity
CRT = Corporate taxes
DP = Dividend payout
LEV = Leverage
FZ = Firm size
GR = Growth
Panel data regression

 Fixed Effect
 Random Effect
 Hausman specification
Diagnostic Tests
 Chow Test
 Bruesh Pagan Test
 Multicollinearity
Results & Discussions
Model 1: Pooled OLS, using 692 observations

Included 100 cross-sectional units
Time-series length: minimum 2, maximum 7
Dependent variable: ROA
Coefficient Std. Error t-ratio p-value

const -18.4764 5.67291 -3.2569 0.00118 ***
CT -7.7533e-07 1.96067e-07 -3.9544 0.00008 ***
DP 1.80451 4.01176 0.4498 0.65299
LEV 10.0769 6.19041 1.6278 0.10402
FZ 3.2075 0.954201 3.3615 0.00082 ***
GR 2.13674 0.650012 3.2872 0.00106 ***
R-squared 0.059117 Adjusted R-squared 0.052260

F(5, 686) 8.620512 P-value(F) 6.19e-08
The table is the findings of regression model used in the study to check the effect of
corporate taxes, dividend payout, leverage, firm size and growth on the firm return on assets. The
OLS model has been estimated in the study to check the common regression results before
finalizing the recommended model of analysis. The value of R-square in the above table is .0591,
the value suggested that the corporate taxes, dividend payout, leverage, firm size and growth have
5 percent effects on the firm return on assets. The value of R-square argued that the variance
explained has small value which makes clear that the model might not be suitable for the analysis
and it is better to check the variance explained by fixed effect model. The regression model has
included another feature that it can be checked for the statistical significance. The same function
can be estimated by f-value. The f-value is 8.620 which is more than the standard f-value and
concluded that the selected model was found statistically significant.
The corporate taxation has been negatively related to the firm return on assets which
concluded that when the country is having higher taxation system on the corporate income then
the firms will have less return on assets in their reports. The negative association between corporate
taxation and return on assets can be been in the negative beta value i.e. -7.7533e-07 which means
that when the corporate taxation has been increased then the ROA will be decreasing. The negative
relationship can be seen in the negative beta value. The t-value of corporate taxation is -3.9 which
is more than the absolute value of t-value i.e. 2. The higher value of t-value for the corporate
taxation argued that the corporate taxation is having significant effect on the firm return on assets.
The corporate dividend payout has been positively related to the firm return on assets which
concluded that when the firm is having higher payout ratio then the firms will have more return on
assets in their reports due to the fact that investors will be attracting towards the higher payment
of dividend. The positive association between corporate dividend and return on assets can be been
in the positive beta value i.e. 1.80451 which means that when the corporate dividend has been
increased then the ROA will also be increasing. The positive relationship can be seen in the
positive beta value. The t-value of corporate dividend is 0.44 which is less than the absolute value
of t-value i.e. 2. The lower value of t-value for the corporate dividend argued that the corporate
dividend is having insignificant effect on the firm return on assets.
The leverage has been negatively related to the firm return on assets which concluded that
when the firm is having higher ratio of debts in their capital structure then the firms will have less
return on assets in their reports. The negative association between leverage and return on assets
can be been in the negative beta value i.e. -10.0769 which means that when the leverage has been
increased then the ROA will be decreasing. The negative relationship can be seen in the negative
beta value. The t-value of leverage is -1.6278 which is less than the absolute value of t-value i.e.
2. The lower value of t-value for the leverage argued that the leverage is having insignificant effect
on the firm return on assets.
The fir size has been positively related to the firm return on assets which concluded that
when the firm is having higher ratio of investment in their assets then the firms will have more
return on assets in their reports due to the fact that investors will be attracting towards the higher
payment of dividend. The positive association between firm size and return on assets can be been
in the positive beta value i.e. 3.2075 which means that when the firm size has been increased then
the ROA will also be increasing. The positive relationship can be seen in the positive beta value.
The t-value of firm size is 3.3615 which is more than the absolute value of t-value i.e. 2. The higher
value of t-value for the firm size concluded that it has significant effect on the firm return on assets.
The firm growth has been positively related to the firm return on assets which concluded
that when the firm is having higher ratio of sales then the firms will have more return on assets in
their reports due to the fact that investors will be attracting towards the higher payment of dividend.
The positive association between firm growth and return on assets can be been in the positive beta
value i.e. 2.13674 which means that when the firm growth has been increased then the ROA will
also be increasing. The positive relationship can be seen in the positive beta value. The t-value of
firm growth is 3.2872 which is more than the absolute value of t-value i.e. 2. The higher value of
t-value for the firm growth concluded that it has significant effect on the firm return on assets.
Model 2: Fixed-effects, using 692 observations

Dependent variable: ROA

Const -26.6044 10.7184 -2.4821 0.01334 **
CT -8.01541e-07 3.23252e-07 -2.4796 0.01343 **
DP 6.8216 5.51398 1.2371 0.21653
LEV -5.10614 7.34667 -0.6950 0.48731
FZ 4.63016 1.78234 2.5978 0.00962 ***
GR 1.89477 0.674489 2.8092 0.00513 ***

F(104, 587) 7.966194 P-value(F) 5.36e-07
corporate taxes, dividend payout, leverage, firm size and growth on the firm return on assets. The
OLS model has been estimated in the study to check the common regression results before
finalizing the recommended model of analysis. The value of R-square in the above table is .2583,
the value suggested that the corporate taxes, dividend payout, leverage, firm size and growth have
25 percent effects on the firm return on assets. The value of R-square argued that the variance
explained has small value which makes clear that the model might not be suitable for the analysis
and it is better to check the variance explained by fixed effect model. The regression model has
included another feature that it can be checked for the statistical significance. The same function
can be estimated by f-value. The f-value is 7.966 which is more than the standard f-value and
concluded that the selected model was found statistically significant.
The corporate taxation has been negatively related to the firm return on assets which
concluded that when the country is having higher taxation system on the corporate income then
the firms will have less return on assets in their reports. The negative association between corporate
taxation and return on assets can be been in the negative beta value i.e. -8.01541e-07 which means
that when the corporate taxation has been increased then the ROA will be decreasing. The negative
relationship can be seen in the negative beta value. The t-value of corporate taxation is -2.4796
which is more than the absolute value of t-value i.e. 2. The higher value of t-value for the corporate
taxation argued that the corporate taxation is having significant effect on the firm return on assets.
The corporate dividend payout has been positively related to the firm return on assets which
concluded that when the firm is having higher payout ratio then the firms will have more return on
assets in their reports due to the fact that investors will be attracting towards the higher payment
of dividend. The positive association between corporate dividend and return on assets can be been
in the positive beta value i.e. 6.8216 which means that when the corporate dividend has been
positive beta value. The t-value of corporate dividend is 1.2371 which is less than the absolute
value of t-value i.e. 2. The lower value of t-value for the corporate dividend argued that the
corporate dividend is having insignificant effect on the firm return on assets.
The leverage has been negatively related to the firm return on assets which concluded that
when the firm is having higher ratio of debts in their capital structure then the firms will have less
return on assets in their reports. The negative association between leverage and return on assets
can be been in the negative beta value i.e. -5.10614 which means that when the leverage has been
increased then the ROA will be decreasing. The negative relationship can be seen in the negative
beta value. The t-value of leverage is -0.6950 which is less than the absolute value of t-value i.e.
2. The lower value of t-value for the leverage argued that the leverage is having insignificant effect
on the firm return on assets.
The fir size has been positively related to the firm return on assets which concluded that
when the firm is having higher ratio of investment in their assets then the firms will have more
return on assets in their reports due to the fact that investors will be attracting towards the higher
payment of dividend. The positive association between firm size and return on assets can be been
in the positive beta value i.e. 4.63016 which means that when the firm size has been increased then
the ROA will also be increasing. The positive relationship can be seen in the positive beta value.
The t-value of firm size is 2.5978 which is more than the absolute value of t-value i.e. 2. The higher
value of t-value for the firm size concluded that it has significant effect on the firm return on assets.
The firm growth has been positively related to the firm return on assets which concluded
that when the firm is having higher ratio of sales then the firms will have more return on assets in
their reports due to the fact that investors will be attracting towards the higher payment of dividend.
The positive association between firm growth and return on assets can be been in the positive beta
value i.e. 1.89477 which means that when the firm growth has been increased then the ROA will
also be increasing. The positive relationship can be seen in the positive beta value. The t-value of
firm growth is 2.8092 which is more than the absolute value of t-value i.e. 2. The higher value of
t-value for the firm growth concluded that it has significant effect on the firm return on assets.
Regression (Firm Value)
Model 3: Pooled OLS, using 692 observations

Dependent variable: FV

Const 1.13115 0.271688 4.1634 0.00004 ***
CT -3.62207e-08 9.39006e-09 -3.8573 0.00013 ***
DP 0.00443056 0.192131 0.0231 0.98161
LEV -0.517763 0.296472 -1.7464 0.08119 *
FZ 0.0189117 0.0456987 0.4138 0.67912
GR 0.125499 0.0311304 4.0314 0.00006 ***

F(5, 686) 8.631360 P-value(F) 6.04e-08
corporate taxes, dividend payout, leverage, firm size and growth on the firm value. The OLS model
has been estimated in the study to check the common regression results before finalizing the
recommended model of analysis. The value of R-square in the above table is .059, the value
suggested that the corporate taxes, dividend payout, leverage, firm size and growth have 5 percent
effects on the firm value. The value of R-square argued that the variance explained has small value
which makes clear that the model might not be suitable for the analysis and it is better to check the
variance explained by fixed effect model. The regression model has included another feature that
it can be checked for the statistical significance. The same function can be estimated by f-value.
The f-value is 8.63 which is more than the standard f-value and concluded that the selected model
was found statistically significant.
The corporate taxation has been negatively related to the firm value which concluded that
when the country is having higher taxation system on the corporate income then the firms will
have less firm value in their reports. The negative association between corporate taxation and firm
value can be been in the negative beta value i.e. -3.62207e-08 which means that when the corporate
taxation has been increased then the ROA will be decreasing. The negative relationship can be
seen in the negative beta value. The t-value of corporate taxation is -3.8573 which is more than
the absolute value of t-value i.e. 2. The higher value of t-value for the corporate taxation argued
that the corporate taxation is having significant effect on the firm value.
The corporate dividend payout has been positively related to the firm value which
concluded that when the firm is having higher payout ratio then the firms will have more firm
value in their reports due to the fact that investors will be attracting towards the higher payment of
dividend. The positive association between corporate dividend and firm value can be been in the
positive beta value i.e. 0.00443056 which means that when the corporate dividend has been
positive beta value. The t-value of corporate dividend is 0.0231 which is less than the absolute
value of t-value i.e. 2. The lower value of t-value for the corporate dividend argued that the
corporate dividend is having insignificant effect on the firm value.
The leverage has been negatively related to the firm value which concluded that when the
firm is having higher ratio of debts in their capital structure then the firms will have less firm value
in their reports. The negative association between leverage and firm value can be been in the
negative beta value i.e. -0.517763 which means that when the leverage has been increased then the
ROA will be decreasing. The negative relationship can be seen in the negative beta value. The t-
value of leverage is -1.7464 which is less than the absolute value of t-value i.e. 2. The lower value
of t-value for the leverage argued that the leverage is having insignificant effect on the firm value.
The fir size has been positively related to the firm value which concluded that when the
firm is having higher ratio of investment in their assets then the firms will have more firm value
in their reports due to the fact that investors will be attracting towards the higher payment of
dividend. The positive association between firm size and firm value can be been in the positive
beta value i.e. 0.0189117 which means that when the firm size has been increased then the ROA
will also be increasing. The positive relationship can be seen in the positive beta value. The t-value
of firm size is 0.4138 which is more than the absolute value of t-value i.e. 2. The higher value of
t-value for the firm size concluded that it has significant effect on the firm value.
The firm growth has been positively related to the firm value which concluded that when
the firm is having higher ratio of sales then the firms will have more firm value in their reports due
to the fact that investors will be attracting towards the higher payment of dividend. The positive
association between firm growth and firm value can be been in the positive beta value i.e. 0.125499
which means that when the firm growth has been increased then the ROA will also be increasing.
The positive relationship can be seen in the positive beta value. The t-value of firm growth is
4.0314 which is more than the absolute value of t-value i.e. 2. The higher value of t-value for the
firm growth concluded that it has significant effect on the firm value.
Model 4: Fixed-effects, using 692 observations

Dependent variable: FV

Const 0.739677 0.375189 1.9715 0.04914 **
CT -2.233e-08 1.13152e-08 -1.9735 0.04891 **
DP 0.481788 0.193012 2.4961 0.01283 **
LEV -0.871961 0.257164 -3.3907 0.00074 ***
FZ 0.0492573 0.0623893 0.7895 0.43013
GR 0.115627 0.02361 4.8974 <0.00001 ***

F(104, 587) 8.602937 P-value(F) 2.34e-68
The table is the findings of regression model used in the study to check the effect of corporate
taxes, dividend payout, leverage, firm size and growth on the firm value. The OLS model has been
estimated in the study to check the common regression results before finalizing the recommended
model of analysis. The value of R-square in the above table is .060, the value suggested that the
corporate taxes, dividend payout, leverage, firm size and growth have 60 percent effects on the
firm value. The value of R-square argued that the variance explained has small value which makes
clear that the model might not be suitable for the analysis and it is better to check the variance
explained by fixed effect model. The regression model has included another feature that it can be
checked for the statistical significance. The same function can be estimated by f-value. The f-value
is 8.60 which is more than the standard f-value and concluded that the selected model was found
statistically significant.
The corporate taxation has been negatively related to the firm value which concluded that
when the country is having higher taxation system on the corporate income then the firms will
have less firm value in their reports. The negative association between corporate taxation and firm
value can be been in the negative beta value i.e. -2.233e-08 which means that when the corporate
taxation has been increased then the ROA will be decreasing. The negative relationship can be
seen in the negative beta value. The t-value of corporate taxation is -1.9735 which is more than
the absolute value of t-value i.e. 2. The higher value of t-value for the corporate taxation argued
that the corporate taxation is having significant effect on the firm value.
The corporate dividend payout has been positively related to the firm value which
concluded that when the firm is having higher payout ratio then the firms will have more firm
value in their reports due to the fact that investors will be attracting towards the higher payment of
dividend. The positive association between corporate dividend and firm value can be been in the
positive beta value i.e. 0.481788 which means that when the corporate dividend has been increased
then the ROA will also be increasing. The positive relationship can be seen in the positive beta
value. The t-value of corporate dividend is 2.4961 which is more than the absolute value of t-value
i.e. 2. The lower value of t-value for the corporate dividend argued that the corporate dividend is
having significant effect on the firm value.
The leverage has been negatively related to the firm value which concluded that when the
firm is having higher ratio of debts in their capital structure then the firms will have less firm value
in their reports. The negative association between leverage and firm value can be been in the
negative beta value i.e. -0.871961 which means that when the leverage has been increased then the
ROA will be decreasing. The negative relationship can be seen in the negative beta value. The t-
value of leverage is -3.3907 which is more than the absolute value of t-value i.e. 2. The lower value
of t-value for the leverage argued that the leverage is having significant effect on the firm value.
The fir size has been positively related to the firm value which concluded that when the
firm is having higher ratio of investment in their assets then the firms will have more firm value
in their reports due to the fact that investors will be attracting towards the higher payment of
dividend. The positive association between firm size and firm value can be been in the positive
beta value i.e. 0.0492573 which means that when the firm size has been increased then the ROA
will also be increasing. The positive relationship can be seen in the positive beta value. The t-value
of firm size is 0.7895 which is less than the absolute value of t-value i.e. 2. The higher value of t-
value for the firm size concluded that it has insignificant effect on the firm value.
The firm growth has been positively related to the firm value which concluded that when
the firm is having higher ratio of sales then the firms will have more firm value in their reports due
to the fact that investors will be attracting towards the higher payment of dividend. The positive
association between firm growth and firm value can be been in the positive beta value i.e. 0.115627
which means that when the firm growth has been increased then the ROA will also be increasing.
The positive relationship can be seen in the positive beta value. The t-value of firm growth is
4.8974 which is more than the absolute value of t-value i.e. 2. The higher value of t-value for the
firm growth concluded that it has significant effect on the firm value.
Conclusion & Recommendations
Discussions
(1986)). Devereux und Griffith (1998, 1999, 2003) expand this model in a oneperiod setting with
respect to inframarginal investment projects with an identical pre-tax rate of return and determine
the effective average tax rate (EATR) (cf. Schreiber/Spengel/Lammersen (2002)). Since a constant
yardstick for measuring the effects of taxation on inframarginal investment projects has not been
integrated into EATR models, Knirsch (2007) generalizes the concept to an investment neutral tax
base. Whereas in case of EMTR the nominal tax rate serves as a yardstick, with inframarginal
projects we need a yardstick that is independent of the project’s pre-tax rate of return (cf. Knirsch
(2007)). The resulting neutrality-based effective tax rate is a multi-period approach that succeeds
in quantifying the tax burden from inframarginal investment projects.
Conclusion
The aim of the current study was to evaluate the effect of corporate taxes on the firm
performance and value in Pakistan Stock Exchange. The area of the study was non financial firms
listed at Pakistan Stock Exchange. At present there are 399 non financial firms as per the Balance
Sheet Analysis of non financial firms 2010-2015. These 399 firms were taken as the population of
the study. The sample is the unit which has been drawn from the population and having the same
When the population of the study is homogenous then the study can use the random sampling
technique (Ahmed, 2004). By random sampling technique, the study takes 100 non financial firms
as the sample of the study. The study collected the non financial firms from 2010 to 2016.
The variables of the current study needs the data to be collected from the published reports
i.e. the income statement and balance sheet of the firm. The variables are quantitative in nature
and their information can be downloaded from the annual reports of the firm or from the report of
State Bank of Pakistan i.e. Balance sheet analysis of non financial firm. The data of the non
financial firms will be collected from 2010 to 2016. The current study is based on the secondary
data and in Pakistan Stock Exchange. The nature of the study is both time series and cross sectional
in nature which makes it panel data. The data of the variables were collected from the sources,
then it is will imported to MS Excel and then the Excel sheet will be imported to Stata v 12. The
recommend models will be run on the data.
Looking at the Corporate Income Tax rates charge around different business communities
of the world an upward trend is clearly visible in all developed and in few under developed
countries. Taxes are considered as an essential item in the company’s financial statements, it is a
significant aspect of every company’s performance. Currently taxation is developed in the manner
it is a challenge for the companies and for their boards and Audit committees. The participation of
boards and audit committees varies by country and organization, in that way their high-level tax
strategies create some more misunderstandings regarding this important aspect. The focus shifted
from solely designing and implementing tax structures to minimizing global income taxes while
accurately accounting for them and the internal controls surrounding this process, this shift has not
come easy for today’s tax executives as Most tax executives see the problem as a “tax” problem
that can only be solved by experienced, highly skilled tax professionals and Tax Lawyers.
However, when you examine the causal factors a little further, you find that it is not so much a tax
problem as it is a “data” problem. To produce accurate, timely and comprehensible global income
tax provisions and required disclosures, every company takes its global financial data, processes
it according to all of its jurisdiction’s tax rules and reports the outcomes in accordance with its
financial reporting standards.
The association amongst investment and financing is the focal issue when we concentrate
on corporate finance. In light of M & M theory, investment choice is isolated from finance
resources because of a progression of strict supposition. Modigliani and Miller (1958) contended
that the cost of capital is no changeable regardless of the leverage ratio is 0% or 100%. Hence the
NPV of upcoming future investment is the main variables that have impacts investment strategy.
Notwithstanding, the truth is not great. A lot of hypothetical and empirical works have tested the
M&M position, contending that a firm's investment strategy is leveraged by liquidity imperatives
and asymmetric information. Jensen and Meckling (1976) concluded that the firm with more debt
tends to over-investment. In actuality, Jensen (1986) got to the conclusion: the part of debt with
hard financial constraints will control the over investment. From an agency problem viewpoint,
Myer (1977) thought that exceedingly leverage firms may dismiss the positive NPV investments
because of irreconcilable circumstances amongst shareholders and banks. Gavish and Kalay
(1983), Green (1984) and Parrino and Weisbach (1999) came to an assention that too substantial
debts misshaped the investment exercises. Financing limit will diminish with leverage ratio
expanding. Without enough capital, the organizations will choose to contribute investments with
stable income every year regardless of the fact that these decisions are not the best ones. That is,
inadequate asset will prompt under-investment.
The effect of financial leverage on an company's investment choice is a focal issue in the
firm financial problems. Modigliani and Miller (1958) irrelevance suggestion is right, a firm's
investment arrangement ought to depend entirely on such elements as the future demand, the
association's updated technology of production, the business sector interest rate, that is, on strategic
determinants of profitability, income, and total assets. A huge hypothetical literature has tested
this position, contending that financing contemplations significantly complicate the investment
association, presenting essential determinants beyond neoclassical basics. In theory, finance tends
to leverage genuine investment decisions when there are lost or inadequate markets because of
transaction cost and information asymmetry that is, outside a MillerModigliani in a world with
incomplete markets, agency problems emerging from collaborations between shareholders,
creditors, and management offer ascent to underinvestment or overinvestment motivating forces;
these agency problems present an extent in which investment may not be completely responsive,
or may be over-responsive, to changes in financial basics.
Investment choices, as choices of strategic nature which start activity in the present to get
better the strategic position of the organization for years to come, must be subjected to risk analysis
that regularly on a very basic level changes the choice. Thusly, risk management turns into the
premise for decision making. Risk is inescapable until the size we don't comprehend what the
future brings. As a result, all management choices are the decision of the measure of the Risk taken
and methods for managing such risk. As needs be, the appraisal of Risk in the investment procedure
is a component of investment alternatives for the firm to decide. Uncertainty with respect to the
arrival of the undertaking decides the Risk of interest in significant projects which ought to be
tended to during the time spent settling on a investment choice. The level of Risk and profitability
of the investment decide its adequacy. Effect of Risk on the firm’s profitability is increased and
relies on upon the way of the investment. Leadership decision making under Risk is a decision
issue in which the manager is thinking about a few options and for each of these choices decides
probability. As far as Risk, leader has more data than in states of instability (Bojana and Kristina.
2011).
Recently, the empirical findings on capital structure and taxes have been to a great extent
leveraged by the equilibrium examination of Miller (1977). DeAngelo and Masulis (1980), for
instance, demonstrate that the presence of non-debt tax shields, for example, assets depreciation
deduction findings and investment tax credits, together with a asymmetric corporate expense code
that does not discount misfortunes, is adequate to topple the leverage insignificance suggestion of
Miller (1977), in any case, the DeAngelo-Masulis model predicts a negative relationship between
the level of investment related assessment shield substitutes for debt and the level of budgetary
leverage utilized by the firm. While the investigation might be seen as an incomplete
acknowledgment of the collaboration between the genuine and financial variables of the firm, it
misses the mark regarding completely joining the beneficial side of the economy since the
association's investment choices and non-debt tax shields are exogenous to the model.
Recommendations
 The findings argued that the corporate taxes have significant effects on the firm
performance, it has been recommended that the management should set the taxes level for
the corporate sector to get revenue for the government but they should offer some
incentives to the sector as well so that they can happily pay their taxes.
 The leverage is having negative relationship with the firm performance, it has been
recommended that the investors in Pakistan are not in favor or debt financing and the firm
always prefers tax yield.
 The firm size has positive relationship with the firm performance, it has been recommended
that the firm should invest appropriate amount of investment in assets which can be use for
the revenue generation.
References:
Ahmed Saeed, (2004), “Modeling Corporate Income Tax liabilities using company accounts”,
Arnold Jens, Cyrille Schwellnus, (2008), “Do Corporate Income Taxes Reduce Productivity and
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Becker et.al (2006), “Corporate Income Tax Reform and Foreign Direct Investment in Germany
–Evidence from Firm-Level Data”, Cesifo Working Paper No. 1722 Category 1: Public
Finance www.ifo.de/~DocCIDL/cesifo1_wp1722.pdf
Dr. Chandan Lal Rohra, Mohammad Salih Memon, and Dr. Mohammad Aslam Memon,
(2009), “Impact of Taxation on Financial Services Business Location Decisions in
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The Effect of Corporate Taxation On Firm Performance and Equity

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THE EFFECT OF CORPORATE TAXATION ON FIRM

PERFORMANCE AND EQUITY

Managing complex evaluation tasks for worldwide, multinational companies spotlight

= 397/100 4 (every 4th firm will be included in the study)

H0: Corporate tax rate has negative effect on ROA

H1: Corporate tax rate has positive effect on ROA

H0: Firm leverage rate has negative effect on ROA

H1.2: Firm leverage rate has positive effect on ROA

H0: Firm size rate has negative effect on ROA

H1.3: Firm size rate has positive effect on ROA

H0: Firm growth has negative effect on ROA

H1.4: Firm growth has positive effect on ROA

H0: Firm dividend payout has negative effect on ROA

H1.5: Firm dividend payout has positive effect on ROA

H0: Firm growth has negative effect on the firm equity

Variables & Measurement

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

Dividend Payout ratio

FS = Log (𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠)

ROA = α + β0 + β1(CRT) + β2(DP) + β3 (LEV)+ β4 (FZ)+ β5 (GR)+ e (1)

Panel data regression

Model 1: Pooled OLS, using 692 observations

Coefficient Std. Error t-ratio p-value

R-squared 0.059117 Adjusted R-squared 0.052260

Model 2: Fixed-effects, using 692 observations

Coefficient Std. Error t-ratio p-value

R-squared 0.258355 Adjusted R-squared 0.126957

Model 3: Pooled OLS, using 692 observations

Coefficient Std. Error t-ratio p-value

R-squared 0.059187 Adjusted R-squared 0.052330

Model 4: Fixed-effects, using 692 observations

Coefficient Std. Error t-ratio p-value

R-squared 0.603835 Adjusted R-squared 0.533646

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