Showing papers on "Capital structure published in 1986"

Asset substitution and the agencycosts of debt financing

Abstract: Agency costs of debt have been advanced in the literature as an important consideration foroptimal corporate debt policies. Recently there have been some doubts concerning the theoretical foundations of the notion that these costs increase as the firm employs more debt. In this paper we examine explicitly the incentive for asset substitution by solving endogenously for the optimal risk policy. The results support the notion that more debt aggravates shareholders' incentives to take risk. We also investigate the marginal agency cost function, and discuss conditions for interior optimal capital structure.

Moral Hazard and Adverse Selection: The Question of Financial Structure

Abstract: This paper looks at the moral hazard and adverse selection problems confronting an entrepreneur offering securities to an uninformed, but competitive financial market The adverse selection aspect of the problem is generated by the unobservable entrepreneur's ability to transform effort into value Moral hazard arises because the investment decision is made subsequent to financing We consider the joint use of both debt and equity, and characterize the equilibrium relation between capital structure and unobservable attributes It is shown that: (1) investment and financing are not separable; (2) there is an underinvestment problem for "better" firms; and (3) simultaneous use of both debt and equity can resolve this difficulty We also establish a connection between expected terminal firm value and debt-promised payment level and between share retention and standard deviation AGENCY PROBLEMS IN CORPORATE finance originated with the influential papers of Jensen and Meckling [11], Myers [17], Ross [21], and Leland-Pyle [14] They show that the market imperfections induced by unobservable actions, lack of contracting ability, and information asymmetry generally lead to second-best outcomes in which the distribution of corporate ownership is achieved only at significant cost These costs take the form of excessive perquisite consumption, overinvestment, underinvestment, and incomplete diversification of personal investment portfolios Moral hazard and adverse selection comprise two forms in which agency problems may take shape Arrow [1] equates these two terms with hidden action and hidden information, respectively Moral hazard arises when the action undertaken by the agent is unobservable and has a differential value to the agent as compared to the principal Adverse selection problems arise when the agent has more information than the principal The resolution of such difficulties has been explored in a number of contexts with both signals and contingent contracting mechanisms These definitions exclude certain agency problems in the delegation literature for which the preference incongruity results from a lack of precommitment rather than some exogenous feature of the model In corporate finance, one would thus identify the Jensen-Meckling paper with moral hazard because perquisites enter the insider's objective differently from outsiders, while * Darrough is from Columbia University and Stoughton is from the University of California, Irvine The second author's research was partially supported by Grant Number 410-83-0786 R-1 from the Social Sciences and Humanities Research Council of Canada This paper was presented at the 1984 meetings of the Western Finance Association in Vancouver and at the 1985 European Finance Association meetings in Bern We thank Kose John and Frans Tempelaar for their comments at the meetings

The Impact of Preferred‐for‐Common Exchange Offers on Firm Value

Abstract: This paper examines the impact of capital structure changes which have no corporate tax consequences. Specifically, exchange offers involving preferred and common stock are analyzed. We find that systematic changes in firm value occur when companies announce preferred-for-common exchange offers. Consequently, we interpret our results to be consistent with a signalling hypothesis. We also find weaker evidence suggesting the existence of agency cost effects or wealth redistributions across security classes. Our findings imply that capital structure changes need not alter the tax status of the issuing firm to affect firm value. SINCE THE ORIGINAL MODIGLIANI-MILLER [28] irrelevance proposition, numerous hypotheses have evolved which attempt to explain why capital structure decisions may be of consequence to the securityholders of a firm. Each of these hypotheses posits the existence of one or more capital market imperfections. Such imperfections include corporate and personal taxes or bankruptcy costs [10, 14, 26], unequal access or imperfect substitutes [11], asymmetric information [15, 30, 31, 33], and agency costs [13, 29, 35]. Because the significance of such imperfections in the "real world" is unknown, the relevance of capital structure decisions becomes an empirical issue. Recent empirical studies suggest that capital structure decisions impact firm value. Masulis [19-22], Dann [8], Vermaelen [36], McConnell and Schlarbaum [18], Mikkelson [24], Dann and Mikkelson [9], Masulis and Korwar [23], Asquith and Mullins [1], and Mikkelson and Partch [25] all document statistically significant security price movements in response to leverage-related, firm-specific events.' These studies suggest the existence of market imperfections which make capital structure decisions relevant. However, which imperfections, singly or in combination, are driving the results is still unresolved. Masulis [22] argues that the observed returns are attributable to a tax effect, a redistribution effect or a tax-based information effect. With the exception of Mikkelson [24], who leaves the question open, the other authors argue that signalling or agency cost effects dominate the tax effect.

Dynamic input-output analysis with distributed activities

Abstract: This paper offers a new approach to economic models in which activities take time. Departing from a standard economic model (Leontiefs dynamic input-output model), we recast the activities from ordinary vectors into temporal distributions. In doing so, we preserve the formal structure and simplicity of the standard model. This is the secret of the power of our approach which asserts itself in the resolution of some open dynamic input-output problems. In particular, we are able to solve models with singular capital structures (i.e., singular derivatives coefficients matrices), unbalanced growth and different time profiles of investment or other production activities. De cost gaet voor de baet uyt. (The cost goes before the benefit.) TEMPORALLY distributed activities are important. De Galan (1980, p. 217) ascribes labor market failure to, among other things, the sluggishness of certain adjustments which results from the fact that activities such as education take time. Furthermore, if one neglects the time used up in the production process, then one will generate too high growth rates as most dynamic economic models actually do. Yet little work has been done on modeling with distributed economic activities. Exceptions are input-output analysis with transit and production lags by Br6dy (1965), or with investment lead times by Gladyshevskii and Belous (1978), Johansen (1978), and Zhuravlev (1982). But these studies are in the realm of balanced growth in which the structure of the problem is the same as in static input-output; Zhuravlev comes closest to our work by inclusion of turnpike results. Temporally distributed activities will be considered single elements in a distribution space and be subjected to the calculus of distributions, which yields simple expressions for seemingly complicated equations involving lags and so on, and solutions to the distributed input-output models. It enables us to resolve open dynamic input-output problems, such as the solution of equations with singular capital structures and analysis of economies with different time profiles of investment or other production activities under conditions of unbalanced growth. It should be mentioned that the same approach is relevant for regional economic models as that of Leontief et al. (1977). Then economic activities are modeled as spatial distributions. This topic is the subject of ten Raa (1984). Similarly, our analysis of distributed activities may serve as a model for capital of circulation and the complete economic system as outlined by Foley (1982). The organization of the present paper is as follows. Section I identifies the economic subjects of this study and develops the central theme: input-output profiles are considered single elements in a distribution space, a concept that is defined in the appendix. Section II analyzes the static input-output model with possibly continuously distributed activities. Section III widens the scope to the case of balanced growth. Section IV handles a pure dynamic model with a possibly singular capital structure. Section V solves the traditional dynamic input-output model. By synthesis of the treatment of continuity (section II) and invertibility (section IV), section VI analyzes the distributed dynamic input-output model. Section VII concludes the paper. I. Productive Capital Productive capital is divided into circulating capital and fixed capital (Marx, 1974, p. 158). Circulating capital is absorbed in production and consists of flows of goods. Fixed capital must merely be present when production takes place and consists of stocks of goods. Circulating and fixed capital are represented by, respectively, the input-output flow coefficients matrix A and the Received for publication February 23, 1984. Revision accepted for publication August 6, 1985. *Tilburg University. I owe Wassily Leontief much for help throughout the study. I would like to thank Erik Thomas whom I consulted for the analysis. Andr'as Br6dy, Duncan Foley, and the late Leif Johansen kindly commented on the first draft. I am grateful to Teun Kloek, Rick van der Ploeg, Albert Verbeek, and Ton Vorst for suggestions on the generalized inverse of the capital matrix. Harm Bart provided some useful references. The paper was presented at the fourth IFAC/IFORS Conference on the Modelling and Control of National Economies, Washington, D.C., June 17-19, 1983 and at the Econometric Society Winter 1985 meetings, New York City. Travel support by the Netherlands Organization for the Advancement of Pure Research (Z.W.O.) is gratefully acknowledged. [ 300 1 Copyyrght 1986 This content downloaded from 157.55.39.159 on Sun, 22 May 2016 06:06:25 UTC All use subject to http://about.jstor.org/terms DYNAMIC INPUT-OUTPUT ANALYSIS 301 input-output stock coefficients matrix B, both of Leontief. Circulating capital (A) is fluid, but it can be like water or like syrup. Some circulating capital, such as electricity, is absorbed immediately, but other circulating capital, such as minerals, must be treated during some time. Electricity is (super) fluid capital; minerals are working capital. (Super) fluid capital is, by definition, processed instantaneously; working capital is defined to be capital in the pipe line. The same distinction can be made with regard to fixed capital (B). Some fixed capital, such as a stapler, is ready for immediate use, but other fixed capital, such as a transport container, must be present some time in advance. A stapler is instant capital; the container is advanced capital. Instant capital is fixed capital which can produce instantaneously, while advanced capital must be installed in advance, all by definition. A good starting point for the incorporation of the production times in the circulating and fixed capital matrices A and B is Marx (1974, p. 239). For example, if input i's production time in sector j equals Tij, then we can write interindustry demand for i at time 0 as Ejaijxj(ij) where x(t) is the output vector at time t. In general, the ith input requirement for one unit of sector j th output is represented by an input profile on the past. We shall now introduce a powerful point of view. Giving up the idea of a being some number altogether, we redefine an input-output coefficient as a nonnegative distribution on the nonpositive time axis. The width of its support (Tij) reflects the production time. This set-up obviously applies to capital stock coefficients as well. Then the width of the support of the distribution reflects the investment lead time. II. Static Input-Output Analysis An input-output flow coefficient aij is a nonnegative distribution with nonpositive support, where i] j = 1,..., n represent the sectors of the economy. The future and current flow requirements exercised by sector j-with output distribution xi-on sector i at time t sum up to, heuristically, 0 a11(s)xj(t s) ds, s =-00 abstracting from technical change. Summing over j, which may be done under the integral sign, we obtain interindustry demand for i at time t: JI , a,j(s)xj(t s) ds. s -00j=1 The material balance for good i at time t between output and interindustry demand plus final demand zi reads On Xi(t) = | E aij(s)xj(t s) ds + zi(t). = _00 = Letting x, z and A denote the output and final demand vectors and the input-output flow coefficients matrix, x(t) = f0 A(s)x(t s) ds + z(t). S _ -00 Invoking the notation for the convolution product (appendix), we obtain x=A*x+z. (1) Formulation (1) is free of integrability requirements. It holds for x and z n-dimensional vector distributions and A an n x n-dimensional matrix distribution (nonnegative and with nonpositive support) over time in the sense of Schwartz (1957). The purpose of this section is to solve the Leontief planning problem of finding output x fulfilling (1) given final demand z. Our input-output distribution aij is essentially the outgrowth of temporal disaggregation of a traditional input-output coefficient. Thus, summing over time we capture the traditional coefficient, now denoted fai1. This expression is shorthand for

Announcement effects of withdrawn security offerings: evidence on the wealth redistribution hypothesis

Abstract: This paper employs the comparison period returns approach to examine issuance and withdrawal announcement effects for stock portfolios of firms announcing equity or debt issues that are subsequently withdrawn. In contrast to previous literature, which generally attributes financing announcement effects to capital structure changes, the conclusion of this paper is that security price changes at the time an issue is announced or withdrawn prevent wealth redistributions between insiders and outsiders. Empirical findings are inconsistent with the interpretation of announcement effects as capital structure effects.

Corporate Financing: Too Much Debt?

Abstract: Are U.S. corporations overburdened with debt? Since 1970, internal funds have been taking wider swings as percentages of total funds sources, as compared with the 1950s and 1960s. Furthermore, use of debt financing has been consistently higher since the mid-1960s than during previous periods throughout the century. And short-term debt has accounted for most of this rise. After adjustment for inflation, however, the figures indicate that, since 1974, corporations have relied heavily on internal funds and cut their cost of debt financing to levels that are not high by historical standards. Despite fluctuations in internalfunds and increased use of short-term debt, corporations do not appear to have significantly riskier capital structures than they've had in the past. An examination of determinants of the composition of capital structure reveals that corporate reliance on debt financing increases as capital expenditures rise relative to available internal funds. Use of debt financing is limited, however, by investors' perceptions of the riskiness of the business environment and by relative supplies of federal government securities. Over long periods, furthermore, the tax system seems to affect the level of debt financing; corporate borrowing increases as personal income tax rates rise above corporate levels.

Some Observations on Capital Structure and the Impact of Recent Recapitalizations on Share Prices

Abstract: This paper discusses two fundamental issues in capital structure theory and analyzes the recent recapitalizations of Phillips and Unocal. It is shown that a value-maximizing capital structure may be inconsistent with shareholder utility maximization and that the Miller debt and taxes equilibrium may be inconsistent with a complete capital market. In spite of these and other unresolved issues, the markets's reactions to the recent recapitalizations of Phillips and Unocal are consistent with the predictions of capital structure theory. Except for small redistribution effects against bondholders, the recapitalizations per se had no positive impact on common stock values.

A multiperiod theory of corporate financial policy under taxation (capital structure, debt maturity)

Abstract: This paper examines multiperiod corporate financial policy in a world where the only market imperfection is taxation. The optimal financial policy determines the firm's capital structure and debt maturity structure. Two implications of this policy are: (1) there can be a set of debt-asset ratios that is consistent with firm value maximization, and (2) debt maturity structure is irrelevant to firm value.

Corporate ownership, dividend policy and capital structure under asymmetric information

Abstract: This study investigates the role of insider ownership in the dividend policy and the leverage decision of the firm. An asymmetric information model is developed with the proportion of equity owned by insiders, dividend payout, and debt as signals of firm value. Analysis of the model yields testable hypotheses that insider ownership is negatively related to the payout and debt ratio of a firm. Crosssectional regression analysis of leverage and payout ratio on the insider ownership is performed to test for the hypotheses. The hypothesis that firms with large insider holdings have lower leverage than firms with small insider holdings is a joint test of the signalling and risk aversion explanations. An examination of the systematic and nonsystematic risk across closely and widely held firms is used to differentiate between the alternative explanations. The empirical evidence is consistent with the hypotheses that closely held firms have lower leverage and payout ratios compared to widely held firms. Two insider ownership variables: CI) percentage of insider ownership and (2) number of insiders are used to measure ownership control. The percentage of insider ownership is negatively related to the payout and leverage while the number of insiders has a

Does Monetization of Federal Debt Matter?: Evidence from the Financial Markets

Abstract: THE PROPOSITION THAT IN A PERFECT CAPITAL MARKET a firm s total market value is consistent with alternative configurations of its capital structure was established by Modigliani and Miller (1958). More recently, Barro (1974) and Miller and Upton ( 1974) discussed a similar invariance proposition which holds with respect to the financing of government expenditures as well. Specifically, the proposition states that whether a given level of government purchases is tax financed or bond financed is irrelevant. This neutrality argument is based on the presence of intergenerational transfers so that the public equates the current value of the bonds with the present value of future tax liabilities generated by the bonds. Consequently, no net wealth is involved when government bonds are issued, and the public or the "immortal consumer" is indifferent as to whether tax or debt financing is used. The purpose of this paper is to test some hypotheses that emerge from a generalization of this independence proposition in public finance. In particular, the extension of the notion to the irrelevancy of base money in the financing of federal debt is subjected to empirical scrutiny. Fiscal policy is concerned with the financing of government expenditures by either levying taxes or issuing bonds. Determining the proportion of government

Capital Markets and Prices: Valuing Uncertain Income Streams

Abstract: Theory of Choice Under Risk. Equilibrium in a Contingent Commodity Market Economy. Contingent Claim and Security Market Economies. Complete and Incomplete Security Markets. Risk and Return: The Efficient Set. Linear Pricing. The Capital Asset Pricing Model (CAPM). Theory of the Firm: Production and Capital Structure. Multiperiod Consumption and Investment. Multiperiod Valuation. Multiperiod Valuation and Options. Appendix. References. Index.

Optimal Capital Structures for Regulated Public Utilities

Abstract: Between the milestones represented by Modigliani and Miller's (1958, 1963) seminal papers and Miller's (1977) and Myers' (1984) Presidential Addresses to the American Finance Association, there has been a vast outpouring of theoretical and empirical articles dealing with the question of whether or not a “best” capital structure exists and, if it does, how it is determined. In most theoretical models, the “best” capital structure is defined to be that which maximizes the total market value of a firm's securities although Donaldson (1969), Patterson (1984) and others have provided survey data which indicate that this frame of reference and its attendant logic may not be the most relevant one for financial managers.