Showing papers on "Leverage (finance) published in 1980"

Optimal Capital Structure Under Corporate and Personal Taxation

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.

The Importance of a Market-Value Measurement of Debt in Assessing Leverage

Abstract: Leverage (debt-to-equity ratio) is an important variable in issues concerning the risk of a firm and its securities. Hamada [1969] has demonstrated theoretically the relationship between leverage and systematic risk.' Numerous empirical studies have found that leverage is a significant variable in association tests on risk. Yet there is a glaring disparity between the theoretical results and the empirical tests. The theory is based on market-value measures of debt and leverage. With few exceptions, the empirical tests use book-value (accounting) measures.2 Although these studies have generally found leverage to be highly associated with systematic risk, there has been no means to evaluate the potential effect of using the book-value measurement as a surrogate for the market-value measurement. This study provides direct empirical evidence on the comparability of the book-value and market-value measures of leverage in association tests on systematic risk. The first section of this paper provides a brief presentation of the

Leverage and Dividend Irrelevancy Under Corporate and Personal Taxation

Abstract: IN "DEBT AND TAXES," Merton Miller argues that the marginal personal tax disadvantage of debt combined with supply-side adjustments by firms will override the corporate tax advantage of debt and drive market prices to an equilibrium impying leverage irrelevancy to individual firms. Miller's seminal work has significantly enhanced our understanding of the effects of personal taxes on corporate financial decisions and has already stimulated a substantial body of research (e.g., see Kim-Lewellen-McConnell (1979) and Miller-Scholes (1979)). In this paper, we generalize Miller's work in a number of dimensions and conclude that: 1. There are two key properties of the demand-supply interactions of investors and firms which lead to firm level leverage irrelevancy in market equilibrium (section 2). 2. The key demand-side property reveals that the leverage irrelevancy theorem is robust to alternative assumptions about the personal tax code. Moreover, no single security ownership clientele effect is uniquely associated with the theorem. Many different (simple or complex) personal tax codes lead to the theorem and are associated with different (simple and complex) ownership patterns (section 3). 3. In market equilibrium, leverage is irrelevant for firms which issue risky debt even though part of the corporate debt tax shelter is lost in default and recapture is not allowed (section 4).

Taxes and Corporate Capital Structure in an Incomplete Market

Abstract: This paper extends Merton Miller's 1977 analysis of corporate capital structure decisions to the incomplete capital markets case. As in Miller's model, aggregate demand for corporate leverage is curtailed as interest rates on taxable bonds rise. Unlike Miller's model, however, capital structure is not a matter of indifference to all equilibrium shareholders. Market incompleteness and tax arbitrage restrictions combine to prevent marginal rates of substitution from being equalized for all investors and hence their preferences are not unanimous. In addition, costs associated with debt induce a tendency for lower cost firms to issue a larger proportion of total corporate debt.

Incentive Compensation and REIT Financial Leverage and Asset Risk

Abstract: * A recent survey of real estate investment trust (REIT) advisory compensation shows that more than half of these institutions currently use some form of incentive compensation. This compensation structure typically provides some base payment plus a participation in net income, generally when it exceeds some minimum level. The asymmetry present in incentive compensation will be shown to create incorrect motivations for the REIT advisor.

'q,' Corporate Investment, and Balance Sheet Behavior

Abstract: A GOAL OF RESEARCH on the business sector of the flow-offunds model is to analyze real and financial investment decisions of firms. In theory, and in reality, these decisions should be, and are, linked within a simultaneous framework. The cost of capital to a firm is not determined wholly exogenously but depends on its means of financing, and the timing of a firm's capital outlays is contingent upon the availability of funds. Economists have traditionally approached the theory of investment by hypothesizing that decisions first are made about expenditures for physical capital, and then decisions are made about their financing. Such sequential separation of real and financial capital decisions was most elegantly justified in a series of articles by Modigliani and Miller [5]. However, as Stiglitz [7] and others have shown, the proposition depends not only on the existence of perfect capital markets but also on other conditions such as the absence of taxes, equality of borrowing and lending rates, independence of expectations of real returns and firms' financial policies, and the absence of the possibility of bankruptcy (see Scott [6]). In a previous article [2] we presented a two-period model of the firm in which the debt-equity ratio was determined within a framework where firms consider trade-offs of cost and tax advantages of additional debt against real costs of potential bankruptcy. We also indicated, to some extent, how leverage could be expected to influence the firm's real investment decisions. It was shown that the optimum amount of debt in the firm's capital structure depends upon the corporate tax rate, bor-

Real Estate Investment Analysis: New Developments in Traditional Leverage Concepts

Abstract: The advantages of utilizing leverage in real estate investments has received much attention in the past, but little guidance has been offered that shows the investor the most opportune leverage position for a given investment alternative. Traditional leverage concepts are explored in this article, prior to developing a financial indifference point model and a continuous-function degree of financial leverage (DFL) formula. The indifference point and DFL as shown here are relatively simple to calculate and provide additional insights into risk, return and leverage concepts for real estate investments.

Taxes and Corporate Capital Structure in an Incomplete Market

Abstract: This paper extends Merton Miller's 1977 analysis of corporate capital structure decisions to the incomplete capital markets case. As in Miller's model, aggregate demand for corporate leverage is curtailed as interest rates on taxable bonds rise. Unlike Miller's model, however, capital structure is not a matter of indifference to all equilibrium shareholders. Market incompleteness and tax arbitrage restrictions combine to prevent marginal rates of substitution from being equalized for all investors and hence their preferences are not unanimous. In addition, costs associated with debt induce a tendency for lower cost firms to issue a larger proportion of total corporate debt.