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THE EFFECT OF TAXES ON THE APPROPRIATE COUPON RATE STRATEGY FOR ISSUING CORPORATE BONDS

This paper examines the opportunities available to a corporation as a result of issuing bonds at a premium or a discount, rather than at par. These opportunities arise as a result of exploitation of a feature of U.S. tax law. Any difference between the issue proceeds and the stated par value may (has to) be amortized and reflected in the taxable incomes of the corporation and the bondholder. A model is developed which indicates that the corporation's best strategy is to issue pure discount bonds. By doing so the firm can increase its value for a broad range of discount rates, while maintaining its debt service burden constant.