CORPORATE-INCOME TAXATION AND SIGNALING

A signaling model is developed to investigate the consequences of corp orate income taxation in the presence of adverse selection in the equi ty market. The model obtains a unique informationally constrained effi cient equilibrium in which a better quality firm retains more inside e quity, and, as in the complete information case, only profitable firms are supported The corporate income tax affects signaling costs and th e profitability of projects. Numerical experiments with exponential ut ility functions find that the inside equity position of a better quali ty firm increases as the corporate income rme rate rises. This reactio n is, however insensitive to the fnr rate change due to the risk shari ng with the government, which leads to the interesting results that th e corporate income tar only incurs a lower welfare cast than the lump sum tax with the same tax revenue.