Showing papers on "Capital structure published in 1971"

Management of company finance

Abstract: The financial environment flow of funds and taxation finance and accounting investment appraisal - basic methods investment appraisal - further topics capital rationing and risk analysis in imperfect markets corporate strategy and high technology investments introduction to risk and return capital budgeting and the capital asset pricing model option theory stock market efficiency equity share capital longer-term debt finance share price valuation and the cost of capital dividend policy capital structure policy financial planning short- and medium-term sources of finance management of cash management of debtors management of inventory mergers and acquisitions company restructing international financial management small business finance.

A note on dividend irrelevance and the gordon valuation model

Abstract: THE CONTRIBUTIONS of Modigliani and Miller to the theory of corporate finance are justly celebrated:' indeed many authorities would date the development of modern analytical financial theory to their path-breaking 1958 article. Yet, while the points of disagreement between the theory of capital structure expressed in their earlier articles and the traditional theory have been narrowed down to differing empirical assumptions, the same cannot be said of their later article on dividend policy: "Dividend Policy, Growth, and the Valuation of Shares."2 Nine years after the publication of this latter article there continue to co-exist among financial theorists two opposing views on the importance of dividend policy in perfect markets. The first and older view, originally articulated by Myron Gordon,3 and still commanding widespread assent, can be paraphrased by the statement that even in perfect capital markets,4 the existence of uncertainty about the future suffices to make the price of a share dependent upon the dividend policy which is followed: and that in particular, the more generous is the dividend policy, the higher will be the price of the share. Miller and Modigliani on the other hand, have argued that once the investment policy of a firm is given, the price of its shares is invariant with respect to the size of the dividend paid.' The issue between these opposing views cannot be settled by resort to experience, for the fundamental reason that the above hypotheses relate to the effects of dividend policy in perfect capital markets, whereas of course actual securities markets suffer from several imperfections, the most important of which, from the point of view of dividend policy, are the existence of transactions costs and of differential taxes on income from dividends and capital gains." Despite this, there is a paucity of articles on the theoretical differences

Equilibrium in the Pricing of Capital Assets, Risk-Bearing Debt Instruments, and the Question of Optimal Capital Structure

Abstract: After integrating risky debt instruments into the generalized asset pricing model developed by Sharpe and Lintner, we have demonstrated that the required return-to-equity capital in this model is a linear function of the debt-to-equity ratio with a slope equal to the difference between the unlevered cost of equity and the direct cost of debt. Consequently, we take the average cost of capital to be invariant with respect to leverage. The particular nature of the debt instrument issued by the firm does not affect this result.Our analysis supporting the net operating income valuation construct is of interest in that it takes into account not only the variance of the probability distribution of equity returns but also the covariance relationships between these returns and all other returns in the system. Further, we need not rely on assumptions of “equivalent return” classes or arbitrage possibilities to arrive at our solution. More important, our conclusion is quite general in that we demonstrate indifference toward finance with any instrument regardless of its inherent risk characteristics.

The Cost of Capital of Insurance Companies

Abstract: The concept of the cost of capital, which is simply a weighted average of the opportunity cost of the debt and equity components of a firm's capital structure, has proved useful for industrial firms. This article shows that the accounting data contained in an insurance company balance sheet can be construed in a conventional cost of capital framework. The funds which are generated through the medium of the insurance operation such as the loss reserve and the unearned premium reserve in a propertyliability insurance company are considered as "quasi-debt." The loss on operations is one portion of their imputed cost. The constraints which state insurance regulations place upon the portfolio of an insurer represent another element of imputed cost. While estimation of the cost of equity capital of an insurance enterprise differs little from its industrial counterpart, the imputed cost of "quasi-debt" is difficult to quantify. The possibilities for the application of cost of capital analysis in the insurance environment are manifold. To a financial analyst, the balance sheet and income statement of a company represent the raw material of his trade. The accounting data contained in these statements provide only a rough approximation of the financial condition of the company. When, however, the financial analyst takes these figures and rearranges them in order that he may perform ratio analysis of the various components of the balance sheet and income statement, a much finer grained and detailed picture of the company emerges. If the company under analysis is an industrial one, the characteristics of the firm's capital structure are considered to be of great importance. The ratios of debt to equity and debt to total assets are primary measures of financial stability. J. J. Launie, Ph.D., is Associate Professor of Finance in San Fernando Valley State College. He was a consultant to the 1968 California Commission on Tax Reform and at the time this paper was written, Dr. Launie was President of the Western Association of Insurance Professors. This paper was presented at the 1970 Annual Meeting of A-BR-TA. The fundamental capital structural components of an industrial firm are debt, preferred stock and common stock or equity. The cost of capital of an industrial firm is simply a weighted average of the opportunity cost of the individual capital structure components. Since in an industrial company the cost of debt and preferred stock are quite explicit, the cost measurement of these components of the capital structure is relatively simple. The opportunity cost of equity is much more difficult to determine. The rate of return which the stockholders require is usually estimated through the capitalization of dividends and earnings growth. There are many formidable statistical problems encountered in this estimation process.' However, in the case of the industrial company the delineation of the capital structure into its various components is clear and the estimation prob'For one approach to estimation see M. J. Gordon, The Investment, Financing and Valuation of the Corporation, Homewood, Illinois: Irwin 1962.

Security Prices in a Competitive Market: More about Risk and Return from Common Stocks

Abstract: This book is a sequel to "An Introduction to Risk and Return from Common Stocks" (The MIT Press, 1969), although it is fully self-contained and can be read independently. Both books describe in non-technical language the behavior of common stock prices as revealed by formal statistical work. In the process they offer a broad survey of recent quantitative academic research on the subject, much of which is currently in an inaccessible form.The earlier book, which the "New York Times" says "rates high as reading for every professional investor," was concerned with the basic factors affecting risk and return from common stocks. The present work is concerned primarily with unusual factors that may influence the value of an investment. It is divided into three parts: the first considers various company decisions that may affect the price of its stock (decisions on capital structure, dividend policy, and acquisitions); the second looks at particular types of activity in the stock (insider trading, short selling, and secondary distributions); while the third considers securities that are convertible to common stock.Richard Brealey continues to cover new ground. Little of the material in this book can be found in existing investments texts, and like his first book, it should provide an invaluable source of information for the professional investor and may well be received in the same spirit.

The dynamics of corporate debt management

Abstract: During the last two decades wide attention has been given in the literature to the problem of "optimal capital structure" of a firm, that is, to the ratio of its debt to its equity. While it appears that two major theories have evolved, neither of the two has been fully accepted or rejected. On the other hand, they both seem to agree that a "target" capital structure exists to which the firm tends to adjust over time. Starting from this point, a less broad but nevertheless important problem deserves full attention: given the capital structure of the firm which is the "target" debt/equity ratio, what should be the proportion of short term to long term debt? Specifically, if the debt/equity ratio is a measurement of the so-called financial risk, how can this risk be controlled over a given planning horizon by a combination of different maturity debt issues? Or is it not true then that the age composition of debt provides a new dimension of financial risk? The goal of this study is two-fold:

Financing with convertible preferred stock, 1960–1967: reply

Abstract: THE COMMENTs by Jerry J. Weygandt and Ronald W. Melicher provide an opportunity to re-examine the conclusions arrived at in the original study.' Before that re-examination, however, I would like to comment briefly on the very interesting data presented by Melicher. After examining 258 large corporate mergers occurring during the 19601968 time period, Melicher concludes (as I did) that the main usage of convertible preferred stock in recent years was in financing corporate mergers and acquisitions. Because of the need to maintain a balanced capital structure, Melicher also suggests that convertible preferred stock will continue to be employed in future corporate merger financing. Weygandt believes that recent changes in accounting conventions will cause convertible preferred stock to disappear as a financing vehicle for corporate mergers. Specifically, he contends that the following conclusion is invalid-". . . there is nothing to suggest that companies will lessen their usage of convertible preferred in financing some non-taxable mergers that are accounted for as a 'pooling of interests.' "12 The reasons cited by Weygandt are: (1) changes in accounting for business combinations; and (2) accounting changes relevant to the disclosure of fully diluted earnings per share. Opinion number 16 on business combinations by the Accounting Principles Board3 indicates that more restrictive requirements will be required if "pooling of interests" is to be employed in accounting for a merger or acquisition. These changes appear to have the effect of eliminating the use of convertible preferred stock when "pooling of interests" is employed. Accordingly, this change in accounting for business combinations will directly affect the usage of convertible preferred stock in financing corporate mergers. (Weygandt, in effect, is pointing out a change in a parameter which was assumed fixed when my study was completed.) Weygandt's second point is that the reporting of fully diluted earnings per share nullifies any earnings leverage; therefore, interested parties of accounting data 'will not be misled into assuming factitious earnings leverage."4 I personally believe the reporting of fully diluted earnings per share, by itself, will have little direct effect on the financing employed for business combinations. In this respect Melicher's preliminary findings for 1969 seem to contradict Weygandt, since data on fully diluted earnings per share were available before these mergers occurred.5 Unfortunately, it will be impossible to determine the effect of reporting fully diluted earnings per share on merger financing, since the method of accounting for business combinations has