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

Year 2018, Volume: 10 Issue: 2, 0 - 0, 31.12.2018

L Jacobs M.j. Swanepoel

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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