Portfolio Choice and Corporate Financial Policy When There Are Tax-Intermediating Dealers

Miller (1977) emphasized that optimal corporate financial policy depends on the tax rates facing the firm as well as the tax treatment accorded bond- and stock-holders. In equilibrium, firms will issues claims that are held by the full spectrum of investors, from tax-exempt institutional investors to heavily taxed individuals. However, investment banks are tax neutral institutions that can buy corporate securities and reissue them in a financial package with different tax characteristics, effectively severing the link between the securities the firm issues and the securities investors hold. This paper explores the equilibrium theoretical and empirical implications of banks in a Miller model.