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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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Citations
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Journal ArticleDOI
TL;DR: In this article, the authors assume that outside investors have imperfect information about firms' profitability and that cash dividends are taxed at a higher rate than capital gains, and they derive a comparative static result that relates the equilibrium level of dividend payout to the length of investors' planning horizons.
Abstract: This paper assumes that outside investors have imperfect information about firms' profitability and that cash dividends are taxed at a higher rate than capital gains. It is shown that under these conditions, such dividends function as a signal of expected cash flows. By structuring the model so that finite-lived investors turn over continuing projects to succeeding generations of investors, we derive a comparative static result that relates the equilibrium level of dividend payout to the length of investors' planning horizons.

2,681 citations

Book
07 Jul 1998
TL;DR: In this paper, the authors present a framework for analyzing strategies in the context of a large-scale industrial setting, based on the concepts of value maximization and profit maximization.
Abstract: Preface. PART I INTRODUCTION. 1 The Concept of Strategy. Introduction and Objectives. The Role of Strategy in Success. The Basic Framework for Strategy Analysis. A Brief History of Business Strategy. Strategic Management Today. The Role of Analysis in Strategy Formulation. Summary. Self-Study Questions. Notes. PART II THE TOOLS OF STRATEGY ANALYSIS. 2 Goals, Values and Performance. Introduction and Objectives. Strategy as a Quest for Value. Strategy and Real Options. Putting Performance Analysis into Practice. Beyond Profit: Values and Social Responsibility. Summary. Self-Study Questions. Notes. 3 Industry Analysis: The Fundamentals. Introduction and Objectives. From Environmental Analysis to Industry Analysis. The Determinants of Industry Profit: Demand and Competition. Analyzing Industry Attractiveness. Applying Industry Analysis. Defining Industries: Where to Draw the Boundaries. From Industry Attractiveness to Competitive Advantage: Identifying Key Success Factors. Summary. Self-Study Questions. Notes. 4 Further Topics in Industry and Competitive Analysis. Introduction and Objectives. Extending the Five Forces Framework. The Contribution of Game Theory. Competitor Analysis. Segmentation Analysis. Strategic Groups. Summary. Self-Study Questions. Notes. 5 Analyzing Resources and Capabilities. Introduction and Objectives. The Role of Resources and Capabilities in Strategy Formulation. The Resources of the Firm. Organizational Capabilities. Appraising Resources and Capabilities. Putting Resource and Capability Analysis to Work: A Practical Guide. Summary. Self-Study Questions. Notes. 6 Developing Resources and Capabilities. Introduction and Objectives. Developing Resources. The Challenge of Capability Development. Approaches to Capability Development. Knowledge Management and the Knowledge-based View. Designing Knowledge Management Systems. Summary. Self-Study Questions. Notes. 7 Organization Structure and Management Systems: The Fundamentals of Strategy Implementation. Introduction and Objectives. The Evolution of the Corporation. The Organizational Problem: Reconciling Specialization with Coordination and Cooperation. Hierarchy in Organizational Design. Applying the Principles of Organizational Design. Organizing on the Basis of Coordination Intensity. Alternative Structural Forms. Management Systems for Coordination and Control. Summary. Self-Study Questions. Notes. PART III THE ANALYSIS OF COMPETITIVE ADVANTAGE. 8 The Nature and Sources of Competitive Advantage. Introduction and Objectives. The Emergence of Competitive Advantage. Sustaining Competitive Advantage. Competitive Advantage in Different Market Settings. Types of Competitive Advantage: Cost and Differentiation. Summary. Self-Study Questions. Notes. 9 Cost Advantage. Introduction and Objectives. Strategy and Cost Advantage. The Sources of Cost Advantage. Using the Value Chain to Analyze Costs. Summary. Self-Study Questions. Notes. 10 Differentiation Advantage. Introduction and Objectives. The Nature of Differentiation and Differentiation Advantage. Analyzing Differentiation: The Demand Side. Analyzing Differentiation: The Supply Side. Bringing It All Together: The Value Chain in Differentiation Analysis. Summary. Self-Study Questions. Notes. PART IV BUSINESS STRATEGIES IN DIFFERENT INDUSTRY CONTEXTS. 11 Industry Evolution and Strategic Change. Introduction and Objectives. The Industry Life Cycle. Structure, Competition and Success Factors over the Life Cycle. Organizational Adaptation and Change. Summary. Self-Study Questions. Notes. 12 Technology-based Industries and the Management of Innovation. Introduction and Objectives. Competitive Advantage in Technology-intensive Industries. Strategies to Exploit Innovation: How and When to Enter. Competing for Standards. Implementing Technology Strategies: Creating the Conditions for Innovation. Summary. Self-Study Questions. Notes. 13 Competitive Advantage in Mature Industries. Introduction and Objectives. Competitive Advantage in Mature Industries. Strategy Implementation in Mature Industries: Structure, Systems and Style. Strategies for Declining Industries. Summary. Self-Study Questions. Notes. PART V CORPORATE STRATEGY. 14 Vertical Integration and the Scope of the Firm. Introduction and Objectives. Transaction Costs and the Scope of the Firm. The Costs and Benefits of Vertical Integration. Designing Vertical Relationships. Summary. Self-Study Questions. Notes. 15 Global Strategies and the Multinational Corporation. Introduction and Objectives. Implications of International Competition for Industry Analysis. Analyzing Competitive Advantage in an International Context. Applying the Framework: International Location of Production. Applying the Framework: Foreign Entry Strategies. Multinational Strategies: Global Integration versus National Differentiation. Strategy and Organization within the Multinational Corporation. Summary. Self-Study Questions. Notes. 16 Diversification Strategy. Introduction and Objectives. Trends in Diversification over Time. Motives for Diversification. Competitive Advantage from Diversification. Diversification and Performance. Summary. Self-Study Questions. Appendix: Does Diversification Confer Market Power? Notes. 17 Implementing Corporate Strategy: Management of the Multibusiness Firm. Introduction and Objectives. Governance and the Structure of the Multibusiness Corporation. The Role of Corporate Management. Managing the Corporate Portfolio. Managing Individual Businesses. Managing Linkages between Businesses. Managing Change in the Multibusiness Corporation. External Strategy: Mergers and Acquisitions. Summary. Self-Study Questions. Notes. 18 Current Trends in Strategic Management. Introduction. The New External Environment of Business. Managing in an Economic Crisis. New Directions in Strategic Thinking. Redesigning the Organization. New Modes of Leadership. Summary. Notes. Index.

2,618 citations

Book
16 Oct 2005
TL;DR: The most comprehensive treatment of the theoretical concepts and modelling techniques of quantitative risk management can be found in this paper, where the authors describe the latest advances in the field, including market, credit and operational risk modelling.
Abstract: This book provides the most comprehensive treatment of the theoretical concepts and modelling techniques of quantitative risk management. Whether you are a financial risk analyst, actuary, regulator or student of quantitative finance, Quantitative Risk Management gives you the practical tools you need to solve real-world problems. Describing the latest advances in the field, Quantitative Risk Management covers the methods for market, credit and operational risk modelling. It places standard industry approaches on a more formal footing and explores key concepts such as loss distributions, risk measures and risk aggregation and allocation principles. The book's methodology draws on diverse quantitative disciplines, from mathematical finance and statistics to econometrics and actuarial mathematics. A primary theme throughout is the need to satisfactorily address extreme outcomes and the dependence of key risk drivers. Proven in the classroom, the book also covers advanced topics like credit derivatives. Fully revised and expanded to reflect developments in the field since the financial crisis Features shorter chapters to facilitate teaching and learning Provides enhanced coverage of Solvency II and insurance risk management and extended treatment of credit risk, including counterparty credit risk and CDO pricing Includes a new chapter on market risk and new material on risk measures and risk aggregation

2,580 citations

Posted Content
TL;DR: In this paper, a model of corporate leverage choice is formulated in which corporate and differential personal taxes exist and supply side adjustments by firms enter into the determination of equilibrium prices of debt and equity.
Abstract: In this paper, a model of corporate leverage choice is formulated in which corporate and differential personal taxes exist and supply side adjustments by firms enter into the determination of equilibrium prices of debt and equity. The presence of corporate tax shield substitutes for debt such as accounting depreciation, depletion allowances, and investment tax credits is shown to imply a market equilibrium in which each firm has a unique interior optimum leverage decision (with or without leverage-related costs). The optimal leverage model yields a number of interesting predictions regarding cross-sectional and time-series properties of firms’ capital structures. Extant evidence bearing on these predictions is examined.

2,569 citations

Journal ArticleDOI
TL;DR: In this paper, the authors show that current capital structure is strongly related to historical market values, and that firms are more likely to issue equity when their market values are high, relative to book and past market values.
Abstract: It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to historical market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market. IN CORPORATE F INANCE, “equity market timing” refers to the practice of issuing shares at high prices and repurchasing at low prices. The intention is to exploit temporary f luctuations in the cost of equity relative to the cost of other forms of capital. In the efficient and integrated capital markets studied by Modigliani and Miller ~1958!, the costs of different forms of capital do not vary independently, so there is no gain from opportunistically switching between equity and debt. In capital markets that are inefficient or segmented, by contrast, market timing benefits ongoing shareholders at the expense of entering and exiting ones. Managers thus have incentives to time the market if they think it is possible and if they care more about ongoing shareholders. In practice, equity market timing appears to be an important aspect of real corporate financial policy. There is evidence for market timing in four different kinds of studies. First, analyses of actual financing decisions show that firms tend to issue equity instead of debt when market value is high, relative to book value and past market values, and tend to repurchase equity when market value is low. 1 Second, analyses of long-run stock returns fol

2,516 citations

References
More filters
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

Journal ArticleDOI
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