Showing papers on "Capital structure published in 1970"

Taxes, market valuation and corporate financial policy

Abstract: I N A well-known series of papers Franco Modigliani and Merton Miller^ have outlined a general framework for the analysis of the effects of capital structure and dividend policies on the valuation of the corporation under uncertainty. What disagreement remains about their conclusions stems mainly from different beliefs about the effects of various market imperfections on their analysis.Modigliani and Miller themselves have dealt comprehensively with one such imperfection, namely the tax system as it affects corporations directly.^ However, while they have directed attention to the effects of the tax system as it relates to the taxation of corporate income, their papers are characterized by an ailmost total neglec; of the complementary aspect of the system, which is the taxation of individuals. It is the purpose of this paper to extend their analysis to incorporate the effects of those features of the personal tax structure which are relevant for the valuation of the corporation.

Some Analytical Results on Tax Depreciation

Abstract: A mathematical framework for the discussion of accelerated tax depreciation methods for regulated utilities is constructed Using this framework a number of results are derived, some of them novel We show, for example, under what circumstances interested parties such as the customers and the tax collector should rationally prefer flowthrough or normalization The most important conclusion is that, following a switch from straight-line book and tax depreciation to accelerated tax depreciation with flowthrough, very substantial rate increases will always be required after a fixed interval, regardless of the firm's growth rate Effects of accelerated tax depreciation on interest coverage and tax-free dividends are also discussed, and some numerical results are given The model is general enough to allow incorporation of a number of realistic conditions, as, for example, debt in the capital structure and a dispersed life table

Capital structure, precautionary balances, and valuation of the firm: the problem of financial risk

Abstract: A useful distinction is sometimes maintained between business risk associated with uncertainty of receipts generated by a firm's assets and financial risk defined as the probability of incurring penalty costs stemming from liability claims on assets and asset yields. In fact, disagreement in recent literature on the exact role of capital structure in market valuation of business firms is easily interpreted once the risk assumptions of the literature such as perfect certainty, business risk, and financial risk have been identified.

A comment on the capital structure and the cost of capital: a suggested exposition

Abstract: IN A RECENT ARTICLE in this Journal [1], Haim Ben-Shahar attempted to integrate the theory of portfolio asset pricing as developed by Sharpe [7] and Lintner [4, 5] into the theory of corporation finance. Ben-Shahar's initial analysis with an assumption of debt financing at a constant and riskless rate of interest is essentially correct. Unfortunately after abandoning this assumption to permit financing at variable rates of interest related to the risk characteristics of the instrument used, Shahar's analysis becomes less impressive. He fails to recognize that consideration of the effects of levering with risky debt instruments in the context of a portfolio approach to security pricing requires a complete analysis of the effects on the risk characteristics of equity returns.

Response of The Cost of Equity To Leverage: An Alternative Perspective

Abstract: In this paper we examine the change in a corporation's cost of equity as the corporation increases leverage. Standard textbook treatments present the wellknown Modigliani-Miller hypothesis that the cost of leverage increases linearly with increases in the debt-to-equity ratio in keeping with a constant cost of capital for the firm. Less frequently, textbooks present the Modigliani-Miller argument that, if the cost of debt rises with high levels of leverage, the cost of equity will increase at a decreasing rate or even decline in order to keep the overall cost of capital constant. Standard textbook presentations continue with additional discussions concerning tax effects and bankruptcy costs but without mention of the cost of equity. These presentations leave the impression that the cost of equity remains as presented in the Modigliani-Miller framework. In this paper we present theoretical and empirical arguments in support of our claim that the cost of equity increases slowly with moderate increases in debt but increases dramatically as leverage increases sufficiently to cause equity investors to fear bankruptcy. INTRODUCTION What Should Students Know About the Cost of Equity? Two fundamental relationships form the core knowledge base that students should possess about the cost of equity, both from a corporate finance perspective and an investment perspective. First, because debt has a senior payment claim both in the case of normal business operations and in the case of bankruptcy, equity has more risk and the cost of equity is greater than the cost of debt. This holds regardless if the firm uses very little leverage or a great deal of leverage. Second, because debt is cheaper than equity, increasing leverage may increase per unit payments to equity, but at the cost of increasing variability in these payments. This increase in financial risk causes equity owners to demand a higher percentage return. It is the path of this increased required return to equity that we argue is inadequately addressed by textbooks and provides the focus of this paper. Because textbook discussions of the relationship between the cost of equity and leverage typically depend on the theory developed by Modigliani and Miller, we continue with a discussion of their arguments. Modigliani-Miller Model Modigliani and Miller's (1958) Nobel Prize winning paper on capital structure still underpins textbook discussions of capital structure. At the core of their argument is the proposal that a firm's value is determined solely by the cash flow and the risk of the cash flow created by the firm's assets. Thus, under perfect market conditions, the value of the firm, and hence its overall cost of capital, is not influenced by the decision to finance the firm by debt or by equity. This result is referred to as the irrelevance proposal, or as Modigliani-Miller Proposition I (MM I), and is supported by the argument that investors can achieve whatever level of leverage they desire in their investment in a firm by borrowing on their own to supplement their personal equity investment (the "homemade leverage" argument). Because using debt financing replaces the higher cost of equity with lower costing debt, in order for the cost of capital to remain constant, the cost of equity must increase with leverage and must do so at a prescribed rate as shown in equation (1) below. This relationship is referred to as Modigliani-Miller Proposition II (MM II). [RR.sub.equity] = Unlevered Required Return of Equity + D/E * (ROA--Cost of Debt) (1) Where: [RR.sub.requity] l is the required return on equity for a given level of leverage, D/E is the debt-to-equity ratio (measures leverage), and ROA is the expected return on assets. The cost of debt is assumed to be constant across levels of leverage. Thus, the required return to equity is a constantly increasing linear function of leverage as measured by the D/E ratio. …

On the Capital Structure Theorem: Reply

Abstract: IN A RECENT PAPER in this journal [1] I suggested a formulation of a cost of capital theorem, stating that "in equilibrium, within the range of efficient capital structure the firm's cost of capital is constant As the firm moves to inefficient capital structure, the firm's cost of capital rises" This theorem was derived from the theory of investors' behavior towards return and risk,' under a "diversification constraint," ie, that the investor can invest his own capital, with any proportion of borrowed capital either in one stock or in a mixed portfolio of one stock and riskless bonds The purpose of this paper is first to clarify some issues raised in the Comments by Litzenberger and Jones (hereafter L&J) and by Haugen and Pappas (hereafter H&P), and second, to reexamine the theorem when the diversification constraint is removed, ie, when the investor is allowed to diversify his investment among various assets

Ceo Constellation, Capital Structure, And Financial Performance

Abstract: Distinctive from prior research that emphasizes the influences of CEO demographic characteristics on corporate financial strategies, this study uses constellation as the proxy variables for CEO psychological traits and takes into consideration demographic characteristic variables to further analyze the relationship between CEO traits and corporate financial leverage, performance, and growth opportunity. This is an interesting issue worthy of study because shareholders and potential investors are always searching for CEOs that can create and increase values for the firms. The results show that there is a greater proportion of Leo CEOs in high-leverage firms, a greater proportion of Virgo CEOs in low-leverage and high-ROA firms, and a greater proportion of Pisces CEOs in both low- and high-MB-ratio firms. In addition, the CEOs with air-constellation are positively related to ROA. In general, fire-sign and earth-sign CEOs prefer high financial leverage, while air-sign CEOs are averse to such; fire-sign and air-sign CEOs have positive influences on firm profitability, while earth-sign CEOs have negative influences. Moreover, cash compensation will reduce the positive effect of air-sign CEOs on ROA.

Leccións da crise. cara a un novo enfoque na análise do proceso de endebedamento empresarial

Abstract: One of the crucial aspects of the current crisis is the excessive leverage taken on board by the different agents working in the economy. This accumulation of debt is now all too evident and its pernicious effects are being analysed in a multitude of studies. During the expan- sive cycle, neither institutions nor academics warned of the unravelling scenario and its possible consequences. Hence, the recent crisis sh*ould lead us to speculate whether or not the financial leverage in system has been dealt with adequately, or even properly understood. This paper describes previous theoretical approaches to decision taking for capital structure and suggests a new focus which integrates all of them. The second part of the paper investigates the evolution of companies' banking debt in Spain for the period 2000 to 2009 and compares this evolution with that of other European countries (in particular Portugal, Italy, France and Germany). Keywords: Enterprises debt finance / Leverage / Capital structure / Institucional factors / Cul- tural factors / Sociological factors / Firm-especific factors / Debt crises in Europe.