EFFECT OF DEBT-EQUITY TAX BIAS ON THE WACC OF OIL AND GAS COMPANIES IN BRICS COUNTRIES

Abstract

The global financial crisis, highlighted companies’ vulnerability to debt that led to an intensive effort to reduce leverage. The debt-equity ratio points towards financial leverage and therefore has a direct impact on a company’s long-term sustainability. The literature review highlights the fact that tax systems allow for interest payments to be deductible for income tax purposes, while denying such payments on equity. This tax treatment leads to a tax bias towards debt finance. The purpose of the study is to determine the potential tax bias risk of oil and gas companies in BRICS countries exploring the effect of debt-equity tax bias on weighted-average cost of capital (WACC). The annual financial statements of five oil and gas companies in BRICS countries were analysed to determine the effect of debt-equity tax bias on WACC for the period of 2009 to 2016. Evidence of tax biasness related to debt-equity finance is clearly visible in the annual financial statements. The WACC is directly influenced through this phenomenon. The results indicated a significantly inverse relationship between debt-equity and the WACC of oil and gas companies in BRICS countries. The annual financial statements revealed in all cases a tax bias trend. Which can potentially increase risk for the said companies, due to the over exposure to debt, especially in times of financial hardship. Although many of the companies adjusted the WACC based on the lessons learned from the global financial crisis, this still remains a concern. The study proposes that debt-equity tax bias influences WACC and provides some evidence to suggest that managers, directors and shareholders should consider reducing the debt-equity ratio. The study could potentially help regulating authorities to gain insights into debt-equity decisions and how these decisions could potentially influence long-term sustainability and the wealth earning ability of companies in BRICS countries. 

Keywords

• Debt-equity ratio,Capital structure,Taxation,BRICS,Weightedaverage cost of capital

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