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 chan ce that a recession could push it into financial distress. The tax bia s against equity finance reduces the extent to which firms insulate th emselves against aggregate risks. The role of equity in sharing aggreg ate risks leads to the prediction that firms' dividends should vary wi th macroeconomic conditions, after controlling for the effects of rele vant firm-level variables. We present empirical evidence in support of this prediction.