Intrusions of tax law into corporate law

Taxes normally and correctly are considered to be unfortunate and annoying intruders in the elegant world of capital markets and in the already complicated world of corporate law. There are no fewer than eleven different types of intrusions which may be recognized easily. First, because tax law focuses on “recognition” events rather than periodic appraisals of wealth and does not excuse or defer tax on gains from the sale of stock and other capital assets completely, exchanges are discouraged. Similar to brokers' commissions, taxes add to transaction costs and, therefore, discourage transactions. Second, by taxing dividends more harshly than income realized from the sale of stock, and by taxing such dividends less harshly when they are of the intercorporate variety, tax law may affect the dividend policy of a firm. To the extent that a firm's dividend policy is affected, its overall reinvestment policy probably will be affected. Third, the compensation packages offered to managers and other agents of the firm likely will be influenced by tax laws. Recipients may prefer deferred compensation, certain fringe benefits, and particular types of profit-sharing plans. These preferences may make it worthwhile for employers to structure compensation differently than they would have if taxes did not depend on the form of compensation. Stated in terms of the literature on agency costs, a certain compensation package offered to agents may minimize the monitoring costs of the shareholders and creditors of a firm, but tax law may encourage the use of a different package that causes higher agency costs even though such a package may include stock options which on their own may decrease agency costs.