Showing papers on "Leverage (finance) published in 1981"

Sustainable Growth under Inflation

Abstract: pany is unable or unwilling to raise new equity, there exists only one growth rate in sales which is consistent with the maintenance of certain operating and financial ratios. This is the company's sustainable growth rate. When sales increase at a rate different from the sustainable growth rate, one ratio, or a combination of them, must change. Frequently, this means that companies must increase leverage to finance rapid growth. Nominal sales growth can come from two sources: increasing physical volume, and increasing prices. The earlier paper considered a case in which current assets increase in proportion to nominal increases in sales, concluding that inflation can exacerbate a company's sustainable growth problems. When the objective is to maintain a stable capital structure, as defined by the ratio of the total book value of liabilities to the book value of equity, inflationary growth substitutes in large part for real growth. So, if in the absence of inflation a company's real sustainable growth rate is 15%, the comparable figure in the presence of 10% inf tion might be only 8%. This s a sobering conclusion, for it implies that inflation may have a substantial depressing effect on economic growth. Companies experiencing difficulty financing growth in the absence of inflation will find that inflation forces them to choose between increased leverage or reduced real growth. To the extent that companies reduce real growth in response to falling sustainable growth rates, economic growth will suffer. This is essentially Lintner's message in [5]. Johnson [4] extends my early work by distinguishing between the behavior of current liabilities and long-term liabilities under inflation. Johnson looks at a case where current liabilities vary with nominal sales, but where management constrains long-term liabilities to be a constant fraction of the book value of equity. She finds that in general the real sustainable growth rate under these conditions exceeds the one I found, and that in certain cases the real sustainable growth rate can be independent of the rate of inflation, or even vary inversely with it. The Johnson paper suffers from three problems. Just as I did, Johnson ignores the impact of inflation

The trouble with asset allocation

Abstract: A sset allocation models utilizing the scenario-forecasting approach have become increasingly integrated into the investment process of organizations that stress a structured approach to decisionmaking. When used properly, such an approach can provide those organizations with meaningful insights into the factors that determine return and value for individual asset classes. On the other hand, when used in a superficial manner, asset allocation modeling can become a sophisticated method for projecting individual or organizational biases into the valuation process. The risks associated with relying on the asset allocation process are the same as those associated with over-reliance on any quantitative technique. First, the exactness of the answers provided by those techniques tends to attribute a higher degree of accuracy and meaning to the output than it actually possesses. Second, the complexity of the process sometimes obscures the critical assumptions on which the output depends. To the extent that those assumptions are not constantly articulated and re-examined, the value of the process suffers. Although the contribution that this or, for that matter any quantitative technique makes toward effective ,decision-making is that, when properly used, it forces us to state clearly and to quantify all of our assumptions, we must understand the impact of those assumptions on the results. To do so, it is important to examine the process in detail in order to determine at what points changes in inputs will have either a trivial or a determining effect on the results. In general, this kind of sensitivity analysis

Equal Access and Miller's Equilibrium

Abstract: Controversy over the implications of debt and the rationale belying capital structure has seemingly come to rest upon a plateau defined by Miller's equilibrium analysis of aggregate corporate debt [10]. In “Debt and Taxes,” Miller reasserts his contention that whether capital is obtained through debt or equity has no bearing on the market value of the firm and is, therefore, irrelevant--a notion which has long been accepted with some reluctance by the finance academe. When the Modigliani-Miller model was first offered some 20 years ago [11], it was accompanied by a set of assumptions which portrayed the world of corporate finance in such malleable terms as to make the irrelevancy propositions palatable. Adaptation of this theoretical model (by its originators) to its secular counterpart through the imposition of corporate taxes [12] brought about a reassuring reversal of the irrelevancy doctrine, but left in its stead the disconcerting prescription to maximize firm value by financing exclusively via debt. Consideration of tax effects at the personal level by Farrar and Selwyn [7] marked the next concession to reality by capital structure theorists. Instead of alienating the original model still further from observed corporate behavior, this step provided a means of reconciling the overwhelming advantage of debt financing at the corporate level with the ultimate after-tax “consumption possibilities” afforded to individual investors. Miller's analysis explains that corporations are forced to “gross up” nominal interest rates to attract bondholders who must be compensated for their personal tax liability [10]. Potential increases in market value due to the taxdeductibility of interest payments are exhausted in the competitive drive toward equilibrium—at which point there are no gains from leverage. The sanctity of the irrelevance theorem thus appears to have been restored at the aggregate level.

A Theory and Test of Credit Rationing: Some Further Results

Abstract: The arbitrage argument extends to the case of many risk assets: the equilibrium leverage ratio will vary with the riskiness of the asset backing up the loan and variations in leverage will then substitute for variations in the interest rate. However, it can readily be shown along the lines of [Vernon L.] Smith that competition in leverage terms would be insufficient to correct the inefficient allocation of claims produced by the market when the interest rate is fixed.4

Exercising Policy Leverage Through Aid: A Critical Survey

Abstract: This paper considers critically the case for using aid to exert leverage on the policies of recipient governments. After discussing briefly what we know (and do not know) about how to foster growth, efficiency, and equity in developing countries, the paper focuses on the main requirements for “successful” performance and the possibility of monitoring performance in a relatively objective fashion. A brief conclusion stresses the inherent conflicts in any aid allocation policy and the need, in the end, for a fundamentally qualitative and subjective judgement as to what “should” be done.