tobeornottobe

The correct answer was A.
Epler’s first statement is correct. Miller (of Modigliani and Miller) concluded that if investors face different tax rates on dividend and interest income, the advantage for debt financing may be reduced somewhat. This conclusion is supported by international capital structure differences as countries with favorable dividend tax rates tend to use less debt in their capital structure. Epler’s second comment is also correct. When looking at international differences in capital structure, countries that have factors in place such as stronger legal systems and a greater presence of analysts and auditors tend to reduce agency costs and therefore also have lower financial leverage ratios. Note that higher leverage ratios tend to reduce agency costs, but reducing agency costs does not lead to higher leverage ratios.

muffin09 was almost on the right track. this threw me for a loop as well and when i reviewed cfa text bk3 pg127 Miller from M&M relates it to investors facing different tax rates on their div & interest income in their personal taxes. Higher taxes on interest income vs div income = u demand a higher rate of return on debt = higher cost of debt. they add that income from debt pays interest periodically which u pay tax on vs div income where you only pay taxes after u sell the stock.

as for agency costs - higher leverage means there is less freedom for managers to take on additional debt and spend company cash. since there is higher leverage the managers have to pay it off which reduces free cash flow - in essence managers interests are aligned with shareholder interests.

not sure i FULLY understand the 1st part but it is what it is