Faulkender and Smith (2016) find firms operating in countries with higher tax rates tend to use more debt. In years when tax rates are lower, firms are found to decrease leverage levels. Furthermore, they show firms in all countries borrow less than their full borrowing capacity.

Requirement: Critically comment on these findings in relation toModigliani-Miller(M&M) theory (with tax) by answering the following tow questions. .

a) In what respect the above findings are consistent with the prediction of M&M (with tax) theory?

b) In what respect the findings are not consistent with the predication of M&M theory (with tax) and what could be the reason(s)?

Please answersin thebox below.

Reference:Faulkender, M., & Smith, J. M. (2016). Taxes and leverage at multinational corporations.Journal of Financial Economics,122(1), 1-20.