The paper examines whether firms hedge in response to tax incentives, specifically the tax benefits of increasing debt capacity and reducing expected tax liabilities. Using a refined measure of tax function convexity, the authors find no evidence that firms hedge to reduce tax liabilities due to convexity. However, they find that firms hedge to increase debt capacity, with the average tax benefit amounting to 1.1% of firm value. The study also indicates that firms hedge due to expected financial distress costs and firm size. The results highlight the importance of hedging in capital structure decisions and provide the first direct evidence that hedging increases debt capacity and firm value.The paper examines whether firms hedge in response to tax incentives, specifically the tax benefits of increasing debt capacity and reducing expected tax liabilities. Using a refined measure of tax function convexity, the authors find no evidence that firms hedge to reduce tax liabilities due to convexity. However, they find that firms hedge to increase debt capacity, with the average tax benefit amounting to 1.1% of firm value. The study also indicates that firms hedge due to expected financial distress costs and firm size. The results highlight the importance of hedging in capital structure decisions and provide the first direct evidence that hedging increases debt capacity and firm value.