Journal Article•
The Cost of Capital, Corporation Finance and the Theory of Investment
01 Jan 1958-The American Economic Review (Research Foundation of the Institute of Chartered Financial Analysts)-Vol. 48, Iss: 3, pp 261-297
TL;DR: In this article, the effect of financial structure on market valuations has been investigated and a theory of investment of the firm under conditions of uncertainty has been developed for the cost-of-capital problem.
Abstract: The potential advantages of the market-value approach have long been appreciated; yet analytical results have been meager. What appears to be keeping this line of development from achieving its promise is largely the lack of an adequate theory of the effect of financial structure on market valuations, and of how these effects can be inferred from objective market data. It is with the development of such a theory and of its implications for the cost-of-capital problem that we shall be concerned in this paper. Our procedure will be to develop in Section I the basic theory itself and to give some brief account of its empirical relevance. In Section II we show how the theory can be used to answer the cost-of-capital questions and how it permits us to develop a theory of investment of the firm under conditions of uncertainty. Throughout these sections the approach is essentially a partial-equilibrium one focusing on the firm and "industry". Accordingly, the "prices" of certain income streams will be treated as constant and given from outside the model, just as in the standard Marshallian analysis of the firm and industry the prices of all inputs and of all other products are taken as given. We have chosen to focus at this level rather than on the economy as a whole because it is at firm and the industry that the interests of the various specialists concerned with the cost-of-capital problem come most closely together. Although the emphasis has thus been placed on partial-equilibrium analysis, the results obtained also provide the essential building block for a general equilibrium model which shows how those prices which are here taken as given, are themselves determined. For reasons of space, however, and because the material is of interest in its own right, the presentation of the general equilibrium model which rounds out the analysis must be deferred to a subsequent paper.
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TL;DR: In this article, the authors predict that corporate borrowing is inversely related to the proportion of market value accounted for by real options and rationalize other aspects of corporate borrowing behavior, such as the practice of matching maturities of assets and debt liabilities.
12,521 citations
TL;DR: In this article, the American Finance Association Meeting, New York, December 1973, presented an abstract of a paper entitled "The Future of Finance: A Review of the State of the Art".
Abstract: Presented at the American Finance Association Meeting, New York, December 1973.(This abstract was borrowed from another version of this item.)
11,225 citations
Cites background from "The Cost of Capital, Corporation Fi..."
...theorem [7] is proven, and the required return on debt as a function of the debt-to-equity ratio is deduced....
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TL;DR: Corporate Governance as mentioned in this paper surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world, and shows that most advanced market economies have solved the problem of corporate governance at least reasonably well, in that they have assured the flows of enormous amounts of capital to firms, and actual repatriation of profits to the providers of finance.
Abstract: This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world. CORPORATE GOVERNANCE DEALS WITH the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers? At first glance, it is not entirely obvious why the suppliers of capital get anything back. After all, they part with their money, and have little to contribute to the enterprise afterward. The professional managers or entrepreneurs who run the firms might as well abscond with the money. Although they sometimes do, usually they do not. Most advanced market economies have solved the problem of corporate governance at least reasonably well, in that they have assured the flows of enormous amounts of capital to firms, and actual repatriation of profits to the providers of finance. But this does not imply that they have solved the corporate governance problem perfectly, or that the corporate governance mechanisms cannot be improved. In fact, the subject of corporate governance is of enormous practical impor
10,954 citations
TL;DR: In this article, the problem of selecting optimal security portfolios by risk-averse investors who have the alternative of investing in risk-free securities with a positive return or borrowing at the same rate of interest and who can sell short if they wish is discussed.
Abstract: Publisher Summary This chapter discusses the problem of selecting optimal security portfolios by risk-averse investors who have the alternative of investing in risk-free securities with a positive return or borrowing at the same rate of interest and who can sell short if they wish. It presents alternative and more transparent proofs under these more general market conditions for Tobin's important separation theorem that “ … the proportionate composition of the non-cash assets is independent of their aggregate share of the investment balance … and for risk avertere in purely competitive markets when utility functions are quadratic or rates of return are multivariate normal. The chapter focuses on the set of risk assets held in risk averters' portfolios. It discusses various significant equilibrium properties within the risk asset portfolio. The chapter considers a few implications of the results for the normative aspects of the capital budgeting decisions of a company whose stock is traded in the market. It explores the complications introduced by institutional limits on amounts that either individuals or corporations may borrow at given rates, by rising costs of borrowed funds, and certain other real world complications.
9,970 citations
TL;DR: In this article, the authors argue that the legal approach is a more fruitful way to understand corporate governance and its reform than the conventional distinction between bank-centered and market-centered financial systems, and discuss the possible origins of these differences, summarize their consequences, and assess potential strategies of corporate governance reform.
6,387 citations
References
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Book•
01 Jan 1936
TL;DR: In this article, a general theory of the rate of interest was proposed, and the subjective and objective factors of the propensity to consume and the multiplier were considered, as well as the psychological and business incentives to invest.
Abstract: Part I. Introduction: 1. The general theory 2. The postulates of the classical economics 3. The principle of effective demand Part II. Definitions and Ideas: 4. The choice of units 5. Expectation as determining output and employment 6. The definition of income, saving and investment 7. The meaning of saving and investment further considered Part III. The Propensity to Consume: 8. The propensity to consume - i. The objective factors 9. The propensity to consume - ii. The subjective factors 10. The marginal propensity to consume and the multiplier Part IV. The Inducement to Invest: 11. The marginal efficiency of capital 12. The state of long-term expectation 13. The general theory of the rate of interest 14. The classical theory of the rate of interest 15. The psychological and business incentives to liquidity 16. Sundry observations on the nature of capital 17. The essential properties of interest and money 18. The general theory of employment re-stated Part V. Money-wages and Prices: 19. Changes in money-wages 20. The employment function 21. The theory of prices Part VI. Short Notes Suggested by the General Theory: 22. Notes on the trade cycle 23. Notes on mercantilism, the usury laws, stamped money and theories of under-consumption 24. Concluding notes on the social philosophy towards which the general theory might lead.
15,146 citations
01 Jan 1956
TL;DR: Lintner as discussed by the authors discusses the distribution of income of corporations among dividends, retained earnings, and taxes in the context of the Sixtyeighth Annual Meeting of the American Economic Association.
Abstract: Distribution of Incomes of Corporations Among Dividens, Retained Earnings, and Taxes Author(s): John Lintner Source: The American Economic Review, Vol. 46, No. 2, Papers and Proceedings of the Sixtyeighth Annual Meeting of the American Economic Association, (May, 1956), pp. 97-113 Published by: American Economic Association Stable URL: http://www.jstor.org/stable/1910664 Accessed: 26/06/2008 14:06
3,524 citations
TL;DR: The interest in capital equipment analysis that has been evident in the business literature of the past five years is the product of numerous social, economic, and business developments of the postwar period.
Abstract: The interest in capital equipment analysis that has been evident in the business literature of the past five years is the product of numerous social, economic, and business developments of the postwar period. No conclusive listing of these developments can be attempted here. However, four should be mentioned which are of particular importance in this search for a more systematic method for discovering, evaluating, and selecting investment opportunities. These are: (1) the high level of capital outlays (in absolute terms); (2) the growth in the size of business firms; (3) the delegation of responsibility for initiating recommendations from top management to the profit center, which has been part of the general movement toward decentralization; and (4) the growing use of “scientific management” in the operations of the business firm.
774 citations
"The Cost of Capital, Corporation Fi..." refers background in this paper
...Comparing (5) with (6) we see that as long as V2> V1 we must have Y1 > Y2, so that it pays owners of company 2's shares to sell their holdings, thereby depressing S2 and hence V2; and to acquire shares of company 1, thereby raising Si and thus V1....
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Book•
01 Jan 1938
TL;DR: The theory of investment value is a popular topic in finance fandom powered by wikia as discussed by the authors, where many investing theories have been proposed, e.g., investment multiplier theory, investment multiplier with diagram, the theory of the investment multiplier, investment value maximization theory, and investment value minimization theory.
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753 citations
735 citations