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Showing papers on "Physical capital published in 1980"


Journal ArticleDOI
TL;DR: In this paper, the authors analyzed the international capital market and analyzed a wide range of issues including the nation's optimal rate of saving and the incidence of tax changes and found that saving that originates in a country remains 'to be invested there'.
Abstract: How internationally mobile is the world's supply of capital? Does capital flow among industrial countries to equalize the yield to investors? Alternatively, does the saving that originates in a country remain 'to be invested there? Or does the truth lie somewhere between these two extremes? The answers to these questions are not only important for understanding the international capital market but are also critical for analyzing a wide range of issues including the nation's optimal rate of saving and the incidence of tax changes. (This abstract was borrowed from another version of this item.)

2,210 citations


Journal ArticleDOI
TL;DR: In this paper, the authors investigated the relationship between capital inputs and energy inputs and concluded that reproducible capital and energy are, for the most part, complements in the production process.
Abstract: The ease with which energy may be substituted for by other types of inputs is of great importance in predicting economic disruptions arising from energy shortages as well as the energy implications of public policy. Studies of energy substitution in the economies of developed countries have produced differing results. A major reason for the divergent results, according to the authors, could be that two quite-different types of capital inputs - physical capital and working capital - have been used. These two types of capital input behave in quite-different ways, at least as regards their relationship with energy inputs to explore this, the authors incorporated the prices of physical capital, working capital, labor, and energy in a constant-returns-to-scale cost function. The authors conclude that reproducible capital and energy are, for the most part, complements - while working capital and energy are largely substitutes in production. Results lead the authors to explain the differences among previous studies by reference to the way in which the capital input was handled. On the level of aggregate US manufacturing a value-added approach to capital cost would be expected to show capital-energy substitutability, while a service-price approach to capital cost would show complementarity. 21 references, 2more » tables (SAC)« less

150 citations


Journal ArticleDOI
TL;DR: In this article, the problem of determining the optimal time-path for the rate of extraction of a mineral deposit has been studied in the context of non-renewable resource extraction.
Abstract: In a recent paper Levhari and Liviatan (1977) present a refinement of the analysis of Hotelling's (1931) paper on the economics of exhaustible resources. While they examine various aspects of the problem of determining the optimal time-path for the rate of extraction of a mineral deposit, they do not develop an important point raised by Hotelling (1931, 163): that the 'capital investment in developing the mine ... is a source of a need for steady production.' A large initial capital investment is typically required before a mineral deposit can be exploited: investment in infrastructure, overburden removal, shaft-sinking, mining and milling plants, and housing for employees may be necessary. The traditional model tends to ignore these preproduction expenses and treats all extraction costs as variable costs. The present paper argues that when the capital investment which must be undertaken before mining can commence is introduced into the conventional analysis of Hotelling, the optimal rate of extraction is constant over much of the mine's life and does not decline over time as the traditional model prescribes. The results of the present paper are derived from a model of non-renewable resource extraction in which the firm uses physical capital to extract the resource from a fixed resource stock of uniform quality. The rate of extraction, or disinvestment in the resource stock, is constrained by the amount of physical capital owned by the firm. The rate of investment in physical capital is assumed to have no upper bound and disinvestment in physical capital is assumed to be impossible, reflecting the fact that much of the capital invested in exploiting a resource stock may not be transferable to another use once extraction terminates. Various elements of the problem addressed in the present paper have received attention in the recent natural resource economics literature. Heaps and Neher (1980) investigate the optimal harvesting policy for a forest when the harvest rate is constrained; Clark, Clarke, and Munro (1979) use a model of renewable resource extraction to analyse the implications of various assumptions about the degree of malleability of capital (its ability to be transferred to an alternative use) for the optimal exploitation of a commercial fishery; and Puu (1977) discusses models of the extraction process of renewable and non-renewable resource stocks in which the rate of extraction is constrained by the size of the physical capital stock. Puu's model of nonrenewable resource extraction differs from that of the present paper in that the resource stock is assumed to be of nonuniform quality, the rate of investment in physical capital has an upper bound, and disinvestment in

104 citations


Journal ArticleDOI
TL;DR: In this article, the authors formulate models in which the physical production processes and their associated cash flow are analyzed, and compute the present value of the cash flow as a function of characteristics of the production process, this value will also reflect a correct overall capital cost.
Abstract: In all production-inventory planning situations one of the major cost items to be considered is the capital cost for products in inventory and in the chain of process. In practical life as well as in theoretical models such costs are usually determined as a product value multiplied by an interest rate, where this value is computed on a cost-added basis: materials, labour, share of overheads, etc. In this paper we formulate models in which the physical production processes and their associated cash flow are analysed. By computing the present value of the cash flow as a function of characteristics of the production process, this value will also reflect a correct overall capital cost. Adjusting parameters of the physical process will then disclose what values to ascribe to products at different stages of production and assembly. It is shown that usual accounting principles often yield too conservative product values at early stages of production and that if percentage factors for covering overheads, etc., ar...

101 citations


Journal ArticleDOI
TL;DR: In this paper, the authors developed and estimated a model of a capital using firm that one can implement using observable data, and the consistency of the model with the data is tested by checking whether the estimated parameters satisfy the regularity conditions imposed by the theory.

90 citations


Journal ArticleDOI
TL;DR: In this article, the authors study the effect of tax deferral on capital gains tax and show that the optimal liquidation policy is to realize capital losses and defer capital gains under the simplifying assumption that short-term and long-term rates on capital gain and losses are equal.
Abstract: WITH A TAX on realized capital gains, investors realize capital losses and defer capital gains. However, if individuals realize capital gains to consume or for other reasons (such as a cash stock merger) they may defer capital gains tax payments by hedging. The hedge produces a capital loss in one tax year and an equal capital gain in the next tax year. If the hedge is operational, capital gains tax is deferred until death and the capital gains tax is avoided entirely.' With this idealized hedge, the effective marginal tax rate on both short-term and long-term capital gains and losses is zero. Also, investors are indifferent to changes in the actual capital gains rate. Call options and commodity futures contracts are used to construct these hedges. Without transactions costs (no bid-ask spreads and brokerage commission fees),, perfect hedges can indeed be constructed and used to defer capital gains tax, despite IRS regulations designed to discourage their use. Transactions costs may dissipate the hedge's tax benefits, and therefore hedges reduce, but do not eliminate, the capital gains tax's effect on consumption and investment. The loophole in the tax code which enables tax deferral, at least in the absence of transactions costs, arises from the institutional structure of both the options exchange and the commodity futures exchange. A contract writer is not matched with a particular contract buyer. For example, if a call price falls, the call buyer can sell the call, realize a capital loss, and immediately buy a new call. The call writer is not forced to realize a corresponding capital gain. There is a net tax gain at the government's expense. Note that the net tax gain would be zero if the buyer and writer were matched. A tax gain for the buyer would be canceled by a tax loss for the writer. With a blunted but not eliminated capital gains tax, the capital gains tax's effect on optimal investor behavior is quite complex. Under the simplifying assumption that short-term and long-term rates on capital gains and losses are equal, the optimal liquidation policy is to realize capital losses and defer capital gains. With this "lock-in" effect, it is important to study welfare effects of given

84 citations


Journal ArticleDOI
TL;DR: In this article, Modigliani and Merton Miller (M-M) provided the first proof of invariance in corporate finance and showed that the value of a firm does not depend on its financing decisions but only on its risk class and its investment decisions.
Abstract: SINCE 1958 WHEN FRANCO Modigliani and Merton Miller (M-M) provided the first proof, invariance propositions have been central to the theory of corporate finance. M-M stated their proposition in two equivalent forms: that the "value of a firm is independent of its capital structure" and that "the average cost of capital to any firm is completely independent of its capital structure."' The rationale is well known. Given the expected return on assets for a firm, individual arbitrage2 will ensure that the value of the firm is simply this expected return capitalized at the rate appropriate to firms in the same risk class. This rate is the average cost of capital and does not depend upon financing decisions of the firm. Consequently, the value of the firm does not depend upon its financing decisions but only on its risk class and its investment decisions. If taxes, in particular the preferential treatment of interest payments, and failure costs are included in the analysis, the two forms of the original M-M proposition may no longer be equivalent. Even if the financial decisions of the firm do not affect its cost of capital, they still may change the firm's expected earnings by altering its tax liability and probability of failing.3 These changes in expected earnings would affect the value of the firm. It is thus possible for the second form of the original M-M proposition to be true even if the first form is not. Additionally, by altering characteristics of the firm's income stream besides its expected value, changes in capital structure may affect its average cost of capital.4 Then neither form of the M-M proposition would be true. The empirical validity of either M-M proposition then depends (at least partially) upon the empirical relevance of taxes and failure costs. Little testing has been done. Recently Miller [12] has suggested that the size of the net tax subsidy to debt over all market participants and the direct costs of bankruptcy may be small, but little has been done to relate these factors to variations in capital structure. That is what we attempt here. The form of the M-M proposition that we test in this study is that although taxes and costs of failure do not affect the average cost of capital, they do affect expected income and so imply an optimal capital structure. More precisely, measures are constructed of the tax advantage to debt and the costs of failure for 38 major industries, and an attempt

83 citations



Journal ArticleDOI
TL;DR: In this paper, the authors developed an optimal growth model that includes several important new features, such as technological change is endogenously related to the growth of knowledge, and investment may be directed either towards physical capital or knowledge (or both).

67 citations


Journal ArticleDOI
TL;DR: In this paper, the authors extend the analysis of Miller's model to a less restrictive setting, and examine it under incomplete capital market conditions, and costs associated with debt, finding that investors have a positive demand for corporate leverage, and that this demand is curtailed as the taxable interest rate rises relative to the tax-exempt rate.
Abstract: THE VIEW THAT A corporation's optimal capital structure is determined by balancing tax savings against bankruptcy costs has recently come under heavy attack.' Because this view seems to have stemmed initially from an attempt to reconcile theory with empirical observation,2 it is ironic that some of the most damaging attacks have themselves been based on empirical facts. Jensen and Meckling [7], for example, point out that the tax saving-bankruptcy cost tradeoff implies all-equity capital structures in the absence of corporate taxes, yet this is not what we observe prior to 1913. Similarly, Miller [11] argues that the theory implies dramatic secular increases in corporate debt ratios since 1913 and more widespread issuance of income bonds, yet we observe neither. As an alternative to the previous view, Miller has proposed an appealingly simple general equilibrium model of interest rates and security prices in the face of both corporate and personal income taxes. When ordinary income and capital gains are taxed at different rates, he concludes that the relative values of firms in a risk class must be identical, regardless of their capital structures. The original MM proposition that capital structure doesn't matter is thus reestablished, even in a world of taxes. Since Miller's model is based on a number of simplifying assumptions, it is the purpose of this paper to try to extend the analysis to a less restrictive setting. In particular, the basic model is examined under incomplete capital market conditions, and costs associated with debt are introduced. As in Miller's model, it is found that investors have a positive demand for corporate leverage, and that this demand is curtailed as the taxable interest rate rises relative to the tax-exempt rate. Unlike Miller's model, however, the capital structure of any one firm is not found to be a matter of indifference to all shareholders at a market equilibrium. This is attributable in part to the costs of debt, which dictate a tendency for more debt to be issued by those firms with lower costs. In addition, tax arbitrage restrictions, combined with incompleteness of the capital market, prevent marginal rates of substitution between current and future consumption from being equated for all investors. Shareholder preferences are thus no longer unanimous, and equilibrium capital structures will be those which both satisfy a majority of

60 citations


Journal ArticleDOI
TL;DR: In this paper, the authors identify relationships between the two sides of the balance sheet exhibited by these corporations and explain the nature of these relationships, and identify the relationship between them and demonstrate the independence of asset and liability composition.
Abstract: AN INDEPENDENCE OF THE asset and liability composition of the firm is implied in much modern financial theory; the independence of investing and financing decisions is a prominent part of Modigliani and Miller's classic capital structure research. While the separation of financing and investing decisions is an invaluable assumption which greatly simplifies many corporate financial decisions, the actual balance sheets of modern corporations do not exhibit an independence between the two sides of the balance sheet. The purposes of this paper are (1) to identify relationships between the two sides of the balance sheet exhibited by these corporations and (2) to explain the nature of these relationships. The independence of asset and liability composition is explicit in Modigliani and Miller's capital structure propositions [15]. In their 1958 article, they demonstrate that, given a stream of risky earnings, the total market value of the firm and cost of capital are independent of capital structure (M & M's Proposition I). Furthermore, the cutoff rate for an investment project is completely independent of the way an investment is financed (M & M's Proposition III), thus implying a complete separation between the investing and financing decisions of the firm.' The teaching of corporate finance, as reflected in the major textbooks, compartmentalizes the decision areas of finance and, within each compartment, management is assumed to attempt to maximize the firm's wealth, holding the other areas of the firm constant. For example, capital budgeting decisions are made given a cost of capital or required rate of return (a capital project is evaluated independent of how it is financed), or the capital structure is chosen given the character of the firm's assets. Cash, receivables, and inventory balances tend to be optimized independently. There is a tradeoff between the rigor afforded by global models of the firm (such as the CAPM) versus the realism afforded by

Journal ArticleDOI
TL;DR: In this paper, the authors examine the impact of the firm's capital structure on management's choice of accounting methods for long-term construction contracts and examine their respective effects on a company's reported financial position and operating results.
Abstract: The purpose of this paper is to examine the impact of the firm's capital structure on management's choice of accounting methods for long-term construction contracts. These contracts extend over more than one accounting period and therefore the basic problem is determining the amount of income to be recognized in each accounting period. The two methods most commonly used are (a) the completed contract method, and (b) the percentage of completion method. Although both methods are in accordance with generally accepted accounting principles, their respective effects on a company's reported financial position and operating results can vary greatly. The completed contract method recognizes income only after all work on the contract is complete (minor costs which may occur at the end of a contract may be ignored when deciding whether a contract is complete). The percentage of completion method recognises income in proportion to progress on a contract for each period in which construction occurs.


Book ChapterDOI
01 Jan 1980
TL;DR: In this article, the authors introduce a new dimension to the connection between investment and the growth of productivity, and show that an increase in thrift lowers the rate of return on capital and the labor intensity of new machines and thus ultimately lengthens the operating life of all machinery.
Abstract: The labor requirements of machines are fixed forever at the time of construction. The utilization of these machines may change over time. One of the products of this model is a theory of the operating life and labor intensity of capital goods. A machine is retired here when rising wages have absorbed all its revenues. A machine will operate longer the smaller its labor intensity. The labor intensity of the optimal type of new machine depends upon the anticipated course of wages and the rate of interest. These relationships introduce a new dimension to the connection between investment and the growth of productivity. An increase in thrift lowers the rate of return on capital and the labor intensity of new machines, and thus ultimately lengthens the operating life of all machinery. Increased thrift affects productivity through both the lengthening and deepening of capital. An increase in thrift, far from modernizing the capital stock, except temporarily, must eventually increase the average age of machinery.

Posted Content
TL;DR: In this paper, the authors explore the issue of wealth maximization and the implied behavior of the firm, paying particular attention to the results discussed above and how they are affected by the existence of capital income taxes, and find that a tax structure similar to that in existence in the United States influences the cost of capital in a very different way than has been assumed previously.
Abstract: In this paper we explore the issue of wealth maximization and the implied behavior of the firm, paying particular attention to the results discussed above and how they are affected by the existence of capital income taxes. Our results indicate that a tax structure similar to that in existence in the United States influences the cost of capital in a very different way than has been assumed previously and that the relative advantages of debt over equity as a method of finance, and capital gains over dividends as a vehicle for personal realization of corporate profits, may have been greatly overstated. These findings may help to explain certain aspects of corporate financial behavior that have seemed puzzling.


Journal ArticleDOI
TL;DR: Almon et al. as mentioned in this paper examined the effect of the cost of capital on inventory investment and found that it is a highly correlated variable with the opportunity cost of inventory holding, which is a key explanatory variable in any empirical study of inventory behavior.
Abstract: T HEORETICAL models of inventory inl vestment including Belsley (1969), Holt et al. (1960), Whitin (1953) and others invariably suggest that the opportunity cost of inventories should be included as a key explanatory variable in any empirical study of inventory behavior. In the absence of an opportunity cost (or other holding costs), the theoretically optimal inventory holding is infinitely large. Even so, it is rather rare that any financial variable emerges as statistically significant in empirical studies of inventories.1 Michael Lovell, who has written extensively on inventory investment, goes so far as to comment "that the probability of obtaining an interest-rate coefficient with negative sign is 50 percent" (1976, p. 400). Even the MITPennsylvania-Social Science Research Council model, which represents an explicit attempt to specify in detail the channels of monetary policy, fails to include monetary variables in its inventory equation.2 The absence of empirical evidence in support of a cost of capital effect on inventory investment renders uncertain what many economists regard as a major channel of monetary policy. It is often commented that roughly three quarters of the variance in GNP is accounted for by changes in inventory investment. Since monetary policy is commonly viewed as very powerful, it is truly remarkable that so little econometric evidence exists to indicate a cost of capital effect on the most variable component of GNP. This study attempts to re-examine the size and significance of the theoretically important cost of capital effect on inventory investment by utilizing firm specific cost of capital measures, as suggested by the finance theory literature, in a pooled cross section econometric analysis of inventory behavior. The cost of capital measure is computed using the actual balance sheet capitalization particular to each firm in the sample for each point in time. Use of a firm specific cost of capital measure instead of a market interest rate avoids the measurement errors introduced into the analysis by the latter procedure. Risk differences among firms, such as between General Motors and Chrysler, imply substantial differences in capital costs. The errors in measurement problem introduced by a market interest rate will bias towards zero the cost of capital effect. Thus a firm specific cost of capital measure may serve as a more effective opportunity cost variable in an econometric analysis of inventory investment. Perhaps even more critical than the use of firm specific cost of capital measures, the econometric analysis is conducted using two samples of firms with each sample disaggregated by stage of fabrication. The first sample, which includes heavy machinery producing companies, attempts to explain inventory investment behavior for companies that produce output in response to orders. The second sample consists of textile companies that produce output predominantly to stock in anticipation of orders. Aggregation of firms that produce to stock and that produce to order-and, in addition, aggregation of inventories across stages of fabrication-may obscure the underlying behavioral characteristics that operate, in fact, at the individual firm level. As suggested by theory, the findings of this study indicate that the cost of capital is a highly sigReceived for publication May 30, 1978. Revision accepted for publication October 30, 1979. * Federal Reserve Bank of New York. A preliminary draft of this paper was presented at the August 1978 meetings of the Econometric Society in Chicago, Illinois. Financial support for the formative stages of this research was provided by the Computer Science Center of the University of Maryland and from the University Research Board in the form of a faculty research award. The data were provided by the College of Business and Management of the University of Maryland. The author thanks Clopper Almon, Robert Eisner, Irwin Friend, Robert J. Gordon and Joel Popkin for their comments and David Dossetter for very able research assistance. Neither they nor the Federal Reserve Bank of New York nor the Federal Reserve System are responsible for the errors or views contained in this paper. I Studies by Kuznets (1964) and Liu (1963) are among the very few that report statistically significant interest rate effects. 2 The paucity of econometric evidence on behalf of cost of capital effects is nevertheless consistent with the prewar survey of Meade and Andrews (1938) (and others) and the postwar surveys of Crockett, Friend and Shavell (1967) and Shavell and Woodward (1971), which questioned managers on the degrees to which they adjusted inventories in response to changes in financial conditions.


Journal ArticleDOI
TL;DR: The role of long-term asset yields and prices in the complex interrelationships that connect financial and non-financial behavior in an economy like that of the United States is discussed in this paper.
Abstract: THE YIELDS AND PRICES of long-term assets play an important role in the complex interrelationships that connect financial and nonfinancial behavior in an economy like that of the United States. Long-term interest rates are a major component of the cost of financial capital to corporate borrowers and, consequently, a key determinant of physical capital formation through business investment in new plant and equipment. Long-term interest rates may also affect other typically debt-financed physical investments like residential construction, although the evidence there is less straightforward. Equity yields constitute another large component of the cost of corporate financial capital, and hence another determinant of business investment. Movements in equity prices (and, to a lesser extent, bond prices) also account for much of the variation in households' overall wealth positions and thereby importantly influence consumer spending. In sum, long-term asset yields and prices are a large part of the story of how what happens in the financial markets including monetary policy and the financial aspects of fiscal policy affects the nonfinancial economy. In light of the importance of long-term asset yields and prices even in a nonfinan-



Journal ArticleDOI
TL;DR: In this article, the authors present a labor-managed system of the Yugoslav type of 1965-1971, where workers possess neither permanent nor transferable claims on capital assets but are, nevertheless, required by law to maintain the value of the initial capital stock and of any additions to it.

MonographDOI
TL;DR: In this paper, the authors present a collection of papers, originally presented at a 1976 meeting of the Conference on Income and Wealth (CWE), focusing on how real capital can be improved to correspond more closely to an economist's ideal measure of capital in economic analysis and prediction.
Abstract: How is real capital measured by government statistical agencies? How could this measure be improved to correspond more closely to an economist's ideal measure of capital in economic analysis and prediction? It is possible to construct a single, reliable time series for allcapital goods, regardless of differences in vintage, technological complexity, and rates of depreciation? These questions represent the common themes of this collection of papers, originally presented at a 1976 meeting of the Conference on Income and Wealth"

Journal ArticleDOI
TL;DR: This article found that the inclusion of human capital appears to have little meaningful effect on both general capital asset pricing and individual investor portfolio composition, due to the fact that relationships between returns on almost all types of human resources and those of marketable financial assets are so weak as to make these two capital asset groupings effectively separable.
Abstract: In the past 2 decades, much progress has been made in the areas of "human capital theory" and " modern portfolio theory," with profound influence upon academic thought and practice.1 But interestingly enough, though human capital theory recognizes human resources as part of an individual's capital asset holdings and modern portfolio theory deals with the pricing of these holdings, only recently have efforts been made to bring these two areas together.2 Employing a popular extension of the Sharpe-Linter capital asset pricing model which allows for the existence of nonmarketable human capital, this study finds that empirically the inclusion of human capital appears to have little meaningful effect upon both general capital asset pricing and individual investor portfolio composition. This is shown to arise from the fact that relationships between returns on almost all types of human capital and those of marketable financial assets are so weak as to make these two capital asset groupings effectively separable.

Journal ArticleDOI
Klaus Conrad1
TL;DR: In this article, the authors apply the duality approach in the theory of consumer behavior for deriving demand systems to analyse the allocation of assets and liabilities of the private non-bank sector.




Posted Content
TL;DR: This article examined the empirical issue of crowding out by examining the proportion of GDP devoted to private investment in new physical capital in part as a function of the proportion devoted to federal government outlays and found evidence of a definite pattern in which private investment is crowded out by government spending and only partial, i.e., incomplete, crowding.
Abstract: This note has addressed the empirical issue of crowding out by examining the proportion of GDP devoted to private investment in new physical capital in part as a function of the proportion of GDP devoted to federal government outlays. Three alternative models were estimated, all of which revealed evidence of (a) a definite pattern in which private investment is crowded out by government spending and (b) only partial, i.e., incomplete, crowding out.

Journal ArticleDOI
TL;DR: In this paper, the authors 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.
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-