Corporate Equities as Lotteries: Skewness and the Tax Preference for Corporate Debt


The tax preference for interest payments by corporations as compared to dividend payments is a long surviving feature of many tax systems. Many have argued that there is no reason for this preference and so it distorts the capital structure of corporations needlessly. This article argues that because the returns to equity are more positively skewed as compared to debt, individual investors will tend to value equity more than they would value it given only its mean and variance characteristics. The article goes on to argue that in the social aggregate only the mean and variance characteristics persist. As a result, this article argues that the tax preference for debt capitalization instead of equity capitalization may help to align social and individual incentives in investment. The article also discusses how other considerations might diminish or even reverse the sign of the optimal preference for debt. However, this article argues that it is not the case that there is no argument for such a preference based on the nature of the returns to debt and the returns to equity.