1 Debt and Taxes: Evidence from bank financed small and medium sized firms Jan Bartholdy jby@asb.dk and Cesario Mateus cmateus@asb.dk Aarhus School of Business Department of Finance Fuglesangs Alle 4 8210 Aarhus V Denmark ABSTRACT This paper analyzes the impact of corporate taxes on the capital structure in a country where bank financing is the main external financing source. It is found that the existence of a debt tax shield and provisions for tax loss carry-forwards has an important impact on the capital structure of the firm. These results adds to the evidence that taxes matters for the capital structure decision. The main differences between the results in this paper and the existing literature are that these results are obtained from 1) a bank based financing system where asymmetric information and agency problems are solved differently than under a market-based system and 2) the results are obtained from small and medium sized unlisted firms. Keywords: Capital Structure, Debt, Marginal Tax Rate, Taxation, Trade-off Theory JEL classification codes: G3, G32 Wednesday, October 20, 2004 ____________ We would like to thank to the participants of the Financial Management Association Meeting (Denver, USA, 10 th Multinational Finance Society Meeting (Montreal, Canada), 12 th European Financial Management Association Meeting (Helsinki, Finland), 2003 Annual CAF Members Meeting (Sandjberg, Denmark), CEMAF/ISCTE 8 th Anniversary Finance Meeting (Lisbon, Portugal), 4 th Brazilian Finance Meeting (Rio de Janeiro, Brazil), 3 rd Portuguese Finance Meeting (Lisbon, Portugal), seminar participants at Financial Management Association Doctoral Seminar (Dublin, Ireland), Pompeu Fabra University (Barcelona, Spain), Catholic University (Lisbon, Portugal), University of Minho, School of Economics and Management (Braga, Portugal), University of Beira Interior (Covilhã, Portugal) and to the participants in the PhD workshop in Finance at Nyborg, Denmark, for their constructive criticism and helpful comments and suggestions. The usual disclaimer applies. This paper previously circulated under the title “Debt and Taxes: Evidence from a Bank Based System”.