HOW TAX POLICY INDUCES CONGLOMERATE MERGERS

Abstract

The advantages of debt rather than equity capital and capital gain rather than dividend income under present tax policy are well known. Here we show that by shifting the burden of default risk from lenders to shareholders, the conglomerate firm can use relatively more debt, and by raising the likelihood of internal investment opportunities it can offer relatively more income in the capital gain form. Thus the present tax treatments of interest expense and capital gains offer inducements for the conglomerate organization of business enterprise.