The Debt and Non-Debt Tax Shields Trade-Off: A Review

The trade-off between debt and non-debt tax shields has gained momentum among scholars and policymakers, especially in the current economic environment affected by the pandemic and the energy crisis. The literature on the tax shields trade-off arises from the theoretical framework by DeAngelo and Masulis (1980) and has developed over time in a fragmented manner in various disciplinary fields such as accounting, finance, and economics. Using a systematic literature review approach, this study provides an up-to-date survey of the theoretical and empirical literature examining the trade-off between classes of tax shields and its consequences for a firm’s capital structure. The systematic analysis of the results of 46 studies supports the existence of an inverse relationship between debt and non-debt tax shields, consistent with a debt substitution hypothesis. However, conflicting evidence remains regarding this trade-off, as well as on its consequences for the corporate capital structure. More recent research also highlights the importance of considering several moderating factors when examining the relationship between debt and non-debt tax shields.This study encourages further research on the topic. Further investigation on the role of free cash flow and agency conflicts in explaining the tax avoidance-capital structure relationship is needed. Moreover, future studies may consider exploiting the exogenous shock provided by the recent Covid-19 crisis for an in-depth analysis of the impact of non-debt tax shield policies on the corporate capital structure.