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Showing papers on "Leverage (finance) published in 1983"


Journal ArticleDOI
TL;DR: In this paper, the authors examined the relationship between failure rates and leverage ratios for 36 lines of business and found that the results are inconsistent with the irrelevance hypothesis and that the existence of positive bankruptcy costs is not sufficient to ensure that the TS-BC hypothesis will predict the inverse relation.
Abstract: This study finds shortcomings in empirical tests of the capital structure irrelevance hypothesis. The alternative hypothesis is that firms choose value maximizing mixes of debt and equity on account of bankruptcy costs and the tax deductibility of interest payments. Based upon the cross-sectional implications of the tax shelter-bankruptcy cost hypothesis, an alternative test of the irrelevance hypothesis is performed. The test examines the relationship between failure rates and leverage ratios for 36 lines of business. The results are inconsistent with the irrelevance hypothesis. IN THEIR LANDMARK PAPER, Modigliani and Miller [26] demonstrate that under certain assumptions the market value of a firm is independent of its capital structure. These assumptions include the absence of taxes, transactions costs, and bankruptcy costs. Recently, Miller [24] has argued that the introduction of corporate and personal taxes does not alter the capital structure irrelevance result in the absence of bankruptcy costs.1 The inclusion of bankruptcy costs, generally considered in conjunction with the tax deductibility of interest payments, has led others to conclude that capital structure will affect the value of the firm.2 In this case, value-maximizing firms may choose optimal capital structures consisting of both debt and equity. There have been numerous attempts to discriminate empirically between the Miller irrelevance (MI) hypothesis and the tax shelter-bankruptcy cost (TS-BC) hypothesis. Several are discussed in Section I of this paper. There it is argued that studies attempting to measure directly the effect of changes in capital structure on firm values are subject to serious complications and are unable to discriminate between the MI and TS-BC hypotheses. Other studies focus on cross-sectional implications of the MI and TS-BC hypotheses. The cross-sectional tests are based on the assertion that bankruptcy costs may tend to induce firms with greater "business risk" to include less debt in their capital structures, whereas the MI hypothesis does not predict such a relationship. Unfortunately, the existence of positive bankruptcy costs is not sufficient to ensure that the TS-BC hypothesis will predict the inverse relation

358 citations


Journal ArticleDOI
TL;DR: In this paper, the generalized jackknife was used to compare firms that capitalized or expense all or part of their research and development (R&D) costs and those that expensed R&D costs.

231 citations


ReportDOI
TL;DR: This paper examined the relationship between real and financial decisions by corporations, in part to determine the extent to which these biases off set or reinforce each other, and found that patterns of real-and financial behavior are only partially consistent with predictions of various capital structure models (e.g. bankruptcy/agency cost, limited tax shield).
Abstract: The U.S. corporate tax distorts the behavior of both real and financial decisions. With respect to the former, the variation in depreciation allowances and investment tax credit provisions across types of investments leads to widely vazying effective tax rates, especially since 1981. Financial policy is distorted by the differential treatment of debt and equity. The purpose of this paper is to examine, using firm-level panel data, the relationship between real and financial decisions by corporations, in part to determine the extent to which these biases off set or reinforce each other.Our results are tentative and suggest that patterns of real and financial behavior are only partially consistent with predictions of various capital structure models (e.g. bankruptcy/agency cost, limited taxshield)and that there is no obvious offset on the financial side to the tax bias against investment in structures.

155 citations


ReportDOI
TL;DR: In this article, the authors apply some recent advances in corporate capital structure theory to the determination of optimal capital in banking, and suggest explanations for why commercial banks tend to have relatively less capital than nonfinancial firms.
Abstract: This paper applies some recent advances in corporate capital structure theory to the determination of optimal capital in banking. The effects of corporate and personal taxes, government regulation, the technology of producing deposit services and the costs of bankruptcy and agency problems are all discussed in the context of the U.S. commercial banking system. The analysis suggests explanations for why commercial banks tend to have relatively less capital than nonfinancial firms, why commercial bank leverage has tended to increase over time and why large banks tend to have relatively less capital than small banks.

64 citations


Journal ArticleDOI
TL;DR: In this paper, it was shown that an increase in the stock of taxable government debt reduces the equilibrium quantity of corporate debt, and an increase of tax-free government debt reduced the equilibria of corporate equity.

31 citations


Journal ArticleDOI
TL;DR: This paper found that personal tax rates tend to be highly negatively correlated with financial leverage, providing support for the existence of financial leverage clienteles, while KLM's failure to observe a strong negative correlation raises doubts concerning the existence in financial leverage clients.
Abstract: estimates of the marginal, ordinary tax rates of investors, obtained from responses to a survey about their incomes, were found to be only slightly (negatively) correlated with the debt ratios of the firms whose stock they held. KLM's failure to observe a strong negative correlation raises doubts concerning the existence of financial leverage clienteles. The purpose of our study is to provide new evidence concerning financial leverage clienteles based on a different estimator of tax rates of shareholders. The evidence indicates that personal tax rates tend to be highly negatively correlated with financial leverage, providing support for the existence of financial leverage clienteles. In the following section, we discuss the Miller and KLM models of financial leverage clienteles. Section II contains a description of the procedures used for estimating personal tax rates and a description of the data used to test the hypothesis of leverage clienteles. Results and implications of the tests are presented in Section III, and Section IV contains the summary.

21 citations


Journal ArticleDOI
TL;DR: In this article, the authors proposed two additions to the theory of leverage optimization by firms operating in a competitively structured industry, and showed that if the capital market is subject to leverage-related imperfections, firms will choose smaller leverage ratios than they would in the absence of these imperfections.
Abstract: We have proposed two additions to the theory of leverage optimization by firms operating in a competitively structured industry.First, whether the capital market is or is not subject to leverage-related imperfections, the force of entry will cause the long-run relationship between profits, π, and leverage, γ, to be given by the equation(17) π(γ) = 0.Even if it is possible in the short run for firms to add positive increments to profits by increasing γ beyond its current level, competitive pressures will erode these increments completely.Second, if the capital market is subject to leverage-related imperfections, firms will choose smaller leverage ratios than they would in the absence of these imperfections. If, in addition, the industry is subject to the force of entry, optimal leverage ratios will be even smaller. Put another way, each firm's leverage ratio in the long run will reflect not just the impact of imperfections on capital costs, but also the impact of entry on product price, output, and operating profits.

14 citations


Journal ArticleDOI
TL;DR: The standard neoclassical theory of the firm and the theory of finance have developed along somewhat independent paths as mentioned in this paper, where the for mer focuses on production, where the firm is viewed as a participant in the product and factor markets, without any reference to sources of financing or to financial markets.
Abstract: The standard neoclassical theory of the firm and the theory of finance have developed along somewhat independent paths. The for mer focuses on production, where the firm is viewed as a participant in the product and factor markets, without any reference to sources of financing or to financial markets.1 The latter focuses on the valuation of securities in relationship to the financial policies of the firm and to its investment (capital budgeting) decisions.2 The financial theory of the firm sheds light on the valuation of risky claims, as well as on the intertemporal allocation of re sources. Its weakness lies in the fact that it

11 citations


Journal ArticleDOI
TL;DR: In this article, the authors explored the relationship between asset return covariances and the impact of asset stock changes on asset prices and derived a solution for asset prices in a rational expectations equilibrium.

9 citations



Journal ArticleDOI
TL;DR: The 1979 Farm Finance Survey revealed that 42 percent of all farmers are over 55 years of age and these farmers control 48% of all farm assets as mentioned in this paper, which implies that the ownership of about one-half of all farmland will be transferred in the next three decades.
Abstract: The 1979 Farm Finance Survey revealed that 42 percent of all farmers are over 55 years of age and these farmers control 48 percent of all farm assets. This implies that the ownership of about one-half of all farmland will be transferred in the next three decades.

Journal ArticleDOI
TL;DR: In this paper, a correction to The Presidential Address published in the Journal of Finance 37 (May 1982) was made, which was due to the fact that, in computing the (real) return from the ith share, I failed to subtract the tax on the nominal capital gain accruing to that share as a result of inflation.
Abstract: THE FOLLOWING IS A correction to The Presidential Address published in the Journal of Finance 37 (May 1982). It first arises in Equation II.1 (p. 258) and results from the fact that, in computing the (real) return from the ith share, I failed to subtract the tax on the nominal capital gain accruing to that share as a result of inflation, namely: -rmpSj Accordingly, this quantity should be added with a negative sign in the curly bracket in the first equality of 11.1, and in the square bracket in the second equality in II.1 as well as in II.2. Unfortunately this error turns out to affect a good many of the equations, though its magnitude seems small enough so as not to require significant revisions of any major conclusions. Accordingly, and to save space, I will report specific corrections for some basic formulae and only indicate the nature of required changes in most others. In Equation II.4, rC should be replaced by (rp' + pTg'), and, similarly, in Equations II.5 to 13a, 15, and 17, whenever rp appears, it should be replaced by (rp + pTg). Note in particular that the value of leverage given by II.7 and II.14, now becomes

Journal ArticleDOI
TL;DR: In this paper, the authors suggest that only the independent company approach should be employed in rate of return cases of regulated public utilities whose parents own subsidiaries with unequal risk and/or whose parent has its own debt.
Abstract: Public utility regulators choose between “double leverage” and “independent company” approaches to determine the cost of equity capital for electric utility holding companies that have diversified and telephone holding companies that have diversified and issued parent debt. Dissimilarities between these two approaches result in significant differences in cost of capital estimates, in allowed rates of return, and in prices of utility services. No valid support for the “double leverage” approach is found after an analysis of descriptive examples and a general theoretical examination of the two approaches compared against established goals of rate of return regulation. The “independent company” approach is shown to be universally correct. The authors suggest, therefore, that only the “independent company” approach should be employed in rate of return cases of regulated public utilities whose parents own subsidiaries with unequal risk and/or whose parent has its own debt.

Posted Content
01 Jan 1983
TL;DR: In this article, the authors briefly outline four ways that financial markets affect income distribution through negative impacts on savers, leverage, negative real rates of interest, and defaults, and conclude with suggested policy changes that might reduce the adverse impact financial markets have on income distributions.
Abstract: Over the past three decades, agricultural credit has received considerable attention in low income countries as governments have tried to stimulate output and help the rural poor through credit. Recent analyses, however, reveal major problems in many agricultural credit programmes. Cheap credit policies appear to fragment rural financial markets so that resources are not allocated efficiently. Low interest rates also undermine the financial integrity of financial intermediaries and force them to become highly dependent on loanable funds from central banks or external aid agencies. Despite the high hopes held for cheap credit as an effective way to help the rural poor, it tends to increase rather than decrease income concentration. In the discussion that follows, we briefly outline four ways that financial markets affect income distribution--through negative impacts on savers, leverage, negative real rates of interest, and defaults. We conclude with suggested policy changes that might reduce the adverse impact financial markets have on income distributions.

Journal ArticleDOI
Allen H. Seed1
TL;DR: In this paper, the authors propose a new approach to asset management, which pays more attention to cash flows, dividend policies, returns, investment selection, and asset monitoring, and emphasize the importance of cash flow, return, and investment selection.
Abstract: These troubled economic times call for fresh approaches to asset management. Executives have to pay more attention to cash flows, dividend policies, returns, investment selection, and asset monitoring.

Journal ArticleDOI
TL;DR: In this paper, it was shown that if individuals can borrow on personal account and create the same limited liability arrangements and the same protective covenants in loan contracts as corporations, the M-M theorem is valid.
Abstract: The Modigliani-Miller (M-M) theorem asserts that in the absence of transaction costs, taxes and the possibility of bankruptcy, firms' market values are independent of their choice of debt-equity ratio (capital structure). The present paper examines the validity of the theorem in a world with bankruptcy. This problem has received a lot of attention in the financial economics literature.' Stiglitz and others have noted that, in the absence of Arrow-Debreu complete markets or special structures like the Capital Asset Pricing Model, the theorem may fail. The failure occurs because simple portfolio strategies of holding equity (common stock) of an unlevered firm and default-free bonds cannot replicate the return patterns of equity and bonds in a levered firm with limited liability. Merton (I974, I977) used the Black-Scholes (I973) option pricing theory to reinstate the validity of the M-M theorem even when there is the possibility of bankruptcy. However, he assumed that borrowing on personal account for security purchase ('margin loans') is default free. The principle result of the present paper is to show, using the same type of analysis as Merton, that if individuals can borrow on personal account and create the same limited liability arrangements and the same protective covenants in loan contracts as corporations, the M-M theorem is valid. This result is proved in a multi-period context with continuous trading. The implications of the possibility of default on short sales are also examined. The details of contracts required to replicate the return patterns which corporate leverage creates are set out. Moral hazard, protective covenants and agency problems associated with these contracts are discussed at the end of the paper. The analysis in the paper uses the Black-Scholes option pricing theory. An important insight of their work is the analogy between certain corporate liabilities and traded options. They illustrate the close similarity between a European call option and equity in a levered firm. A European call option is the right to buy a particular share at some date, the exercise date, at a particular price, the exercise price. The holder will exercise the option if at the exercise date the share is trading at a price above the exercise price. Equity in a levered firm is the option to buy the firm back from the bondholders if the value of the firm exceeds the face value of the bondholders' claim when the bonds mature. Otherwise, given limited liability, shareholders will default and the bondholders take over the firm. The attractiveness of option pricing analysis is that it does not



Journal ArticleDOI
TL;DR: In this paper, the authors discuss valuation, gains from leverage, and the Weighted Average Cost of Capital as a Cutoff Rate (WACR) as a cutoff rate.
Abstract: (1983). Valuation, Gains from Leverage, and the Weighted Average Cost of Capital as a Cutoff Rate. The Engineering Economist: Vol. 29, No. 1, pp. 1-12.

Journal ArticleDOI
TL;DR: In this paper, the authors seek to ascertain if stock market pricing procedures are operationally efficient in setting prices so as to discriminate against poor-quality management by using Ordinary least-squares regression analysis.
Abstract: This paper seeks to ascertain if stock market pricing procedures are operationally efficient in setting prices so as to discriminate against poor-quality management. Signalling theory suggests management's leverage decision as the means by which managerial quality can be identified. Departures from average leverage, given firm characteristics, are interpreted as indicating managerial quality. Ordinary least-squares regression analysis is used to identify these departures, and to test if shareholders' yields are responsive to them. The results are not always statistically significant, but do provide some support for the signalling hypothesis and for the efficiency of UK security pricing.