An implicit clientele test of the relationship between taxation and capital structure

This paper presents a test for the existence of high and low tax bracket debt clienteles. The test generates some evidence consistent with the implication of debt clientele theory that over time, firms' debt ratios should vary with the relative tax incentives for investors to hold debt. The results, however, do not support the existence of extreme financial leverage clienteles. Rather they are consistent with an incomplete equity market: low tax bracket investors hold the stock of highly levered firms and high tax bracket investors hold the stock of the low leverage firms.