Showing papers on "Capital structure published in 1976"

A theory of optimal capital structure

Abstract: This paper presents a multiperiod model of firm valuation derived under the assumptions that bankruptcy is possible and that secondary markets for assets are imperfect. Given the assumption that the probability of bankruptcy is zero, the model is formally identical to that proposed by Modigliani and Miller. Under plausible conditions the model implies a unique optimal capital structure. Comparative statics analysis is used to obtain a number of testable hypotheses which specify the parameters on which optimal financial policy depends. Implications for the debt policy of the regulated firm are also considered.

Harvard Business School; SSRN; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Harvard University - Accounting & Control Unit

Abstract: This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the 'separation and control' issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears the costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.

The value of the firm under regulation

Abstract: show that, with taxes, an increase in leverage should increase the value of the firm. Since MM examine an unregulated firm, their implicit assumption that earnings before interest and taxes (EBIT) are not affected by a change in the capital structure is correct. As a significant part of the economy is now regulated, it is important to have a valuation equation for regulated firms as well. Unfortunately, the MM formula for unregulated firms may not be appropriate for regulated firms, implying that a new valuation model must be established. Recently it has been pointed out that the ratio of the firm's expected earnings after taxes but before interest to total assets is usually held constant in regulated industries.3 This observation implies that the EBIT are affected by regulation. It has been argued that, in such a case, the correct valuation formula is precisely the one derived by Modigliani and Miller in the absence of taxes. This development may cast doubt on the studies examining regulated industries. However, others4 state that MM's method of valuation with

Capital Structure and the Behavior of the Regulated Firm under Uncertainty

Abstract: burgeoning literature on the effects of regulation. Recently, E. E. Bailey [2], has extended the A-J model to incorporate the familiar peak-load pricing model introduced by P. 0. Steiner [15], but both the original A-J model and subsequent extensions are couched in a riskless setting. In contrast, uncertainty is not only a pervasive aspect of reality, but at a more pragmatic level, risk elements play an important part in regulatory proceedings aimed at setting an allowed rate of return.

Super premium security prices and optimal corporate financing decisions

Abstract: DETERMINATION OF the appropriate capital structure for the wealth maximizing firm is a central topic in the study of business finance and has spawned numerous articles and studies by academicians and practitioners alike. An important segment of this body of literature has received notable acclaim from theoreticians and has served to focus all thinking in this area. It consists, at the risk of oversimplification, of derivations of J. B. Williams' [25, 1938] "Law of the Conservation of Investment Value"-stating that the firm's market value is independent of its financial structure-under ever more general conditions. In their landmark article, Modigliani and Miller [16, 1958] used the now familiar arbitrage argument to prove the Williams' entity theory of value under assumptions which included that firms may be grouped into equivalent risk classes, that corporate debt is riskless, and that perfect capital markets exist. Hamada [8, 1969], in an application of the capital asset pricing model to the problems of business finance, proved the capital structure irrelevance propostion in the absence of the MM risk class assumption. And Stiglitz [23, 1969], also in the context of a market equilibrium model, further generalized the irrelevance thesis to encompass the issuance of risky corporate debt. The systematic investigation of specific types of capital market imperfections has also yielded meaningful results, clarifying both the manner in which markets function and the complex nature of the capital structure problem.' This paper extends the analysis of capital market imperfections by developing positive implications concerning the existence of specific institutional portfolio restrictions for firms' financing decisions. In a companion paper2 a single period, two parameter capital asset pricing model was utilized to demonstrate that statutory investment restrictions imposed on the portfolio choices of major financial institutions and certain practices accompanying the shorting of securities combine to create a market situation wherein some securities sell at unwarranted price premiums from the viewpoint of firms' shareholders. The present paper introduces wealth maximizing firms into this equilibrium model as active decision agents seeking to optimize financial structure by issuing both debt and equity securities. The analysis indicates that some, but not

Leverage, Exposure Ratios and the Optimal Rate of Return on Capital for the Insurer

Abstract: The impact of insurance leverage on equity return for property and liability insurers is examined. Two financial models are developed to determine the exposure ratio and associated degree of insurance leverage to maximize the rate of return on insurance stockholder's equity. The optimal degree of insurance leverage is determined by the exposure ratio or quantity of sales which maximizes the rate of return on equity under the financial models specified herein. Accordingly, this study focuses on the use of reserves as a leverage source and attempts to establish a concept of optimal insurance leverage under certain specified conditions. The nature and impact of financial leverage on the return on equity for the non-insurance enterprise have been extensively analyzed in the financial literature.' In contrast, a similar type of leverage available to the non-life insurance company has received little attention in the insurance literature. Although a number of articles on the rate of return of non-life insurance Tapan S. Roy is Associate Director of Corporate Research, The Travelers Insurance Companies and Adjunct Faculty in the School of Business Administration, University of Connecticut. He is President of the Operations Research Society, Valley Chapter, Connecticut. Robert Charles Witt is Associate Professor of Actuarial Science and Insurance in The University of Texas, Austin. He is Secretary of the Risk Theory Seminar and an Assistant Editor of this Journal This paper was presented at the 1974 Annual Meeting of ARIA. The authors would like the acknowledge the constructive reviews of an earlier draft of this paper by Joseph L. Launie, Bernard Shorr, John W. Caron, Lewis J. Spellman, A. J. Senchack, and two anonymous referees. Our special thanks are due to David A. Trespacz who programmed the algorithms to determine the optimal solutions to the models developed in this paper. 'Debt and equity financing are important elements in the capital structure of corporations. Accordingly, the debt to equity ratio has been of interest to financial theorists and analysts. In essence, financial leverage reflects the amount of outside borrowed funds (debt) that the corporation uses in proportion to equity in financing its assets. The purpose for using debt in the capital structure is basically to increase the rate of return on equity over the returns derived from assets. Of course, this result is not obtained unless the return on assets exceeds the relative cost of debt. If the returns on assets are less than the cost of debt, financial leverage is unfavorable and the return on equity is reduced by using it. Thus, leverage can have a favorable or unfavorable impact on the return on equity. A discussion of leverage and appropriate literature references can be found in most corporate finance textbooks. For example, see: J. Fred Weston and Eugene F. Brigham, Managerial Finance (4th edition; New York: Holt, Rinehart and Winston, Inc. 1972), pp. 249-71.

Why Not Deregulate Bank Debt Capital

Abstract: Profit-maximizing nonbanking firms often use debt financing as a source of funds. They borrow long-term, repay the specific debt on a scheduled basis, and refinance the debt as needed. Long-term debt financing is part of the firms' overall capital structure. In making these financing decisions, financial managers analyze expected investment returns, costs and risks of alternate sources of funds, and the impact on owner wealth. In contrast to nonbanking firms, banks issued longterm debt instruments primarily during the 1930's. Facing supervisory mandates to increase long-term capital and identifying limited opportunities to sell additional stock, many banks borrowed long-term funds, especially from the Reconstruction Finance Corporation. Under these circumstances, bank debt capital reflected an aura of bank weakness, and issuing banks that survived the 1930's moved rapidly to eliminate stigmatic long-term debt from their balance sheets.

Optimal financing and capital structure programs for the firm: comment

Abstract: to obtain such a maximum for the model The two inequalities prove to be very critical for the paper since all the solutions and the stability conditions for the model are directly related to the parameters and limits of these constraints4 Although they play such a crucial role, the properties of these inequalities are not carefully thought out and explained by Krouse Their theoretical foundations, empirical contents, and most importantly, the properties of their parameters are not properly set forth The only explanation offered for the