CORPORATE FINANCIAL POLICY, TAXATION, AND MACROECONOMIC RISK

This article formalizes the intuition that equity provides firms with a cushion against aggregate fluctuations. We show that equity allows a firm to share aggregate risks with its creditors, minimizing the chance that a recession could push it into financial distress. The tax bias against equity finance reduces the extent to which firms insulate themselves against aggregate risks. The role of equity in sharing aggregate risks leads to the prediction that firms' dividends should vary with macroeconomic conditions, after controlling for the effects of relevant firm-level variables. We present empirical evidence in support of this prediction.