The Capital Structure Paradigm

Evolution of Debt/Equity Choices

Zane Swanson, Bin Srinidhi, Ananth Seetharaman

• Publisher: Bloomsbury Publishing
• Year: 2003
• eBook ISBN: 9780313072505
• Edition: 0
• Topic: Business
• Subtopic: Business General
• Index: Business

Beginning with a simple model of the debt/equity impact upon firm value and progressively adding complexity to this model, this book seeks to answer the question, What is the frontier of knowledge with respect to debt/equity alternatives, and could a major paradigm shift affect debt/equity choices? With a view toward providing the reader with a framework for examining debt/equity decisions, this book begins with a simple model of the debt/equity impact upon firm value. Utilizing the paradigm development of capital structure theory to identify the current research frontier of the factors affecting the firm debt/equity position, the authors also extrapolate from the current frontier to outline future opportunities for research and improvements in capital structure analysis. Each chapter begins with a discussion of a central tenet, moves on to a discussion of the theoretical research and empirical evidence pertaining to the tenet, and concludes with a summary of the implications of the paradigm shift for current and future research and practice. A chapter at the end of the book provides an analysis of some unanswered questions in the current frontier of knowledge that may be exploited for further research. One is the strength of signaling of capital structure changes on firm value. A second is a lack of specification for the set of capital structure simultaneous equations. A third emerging issue is the definition of the capital structure within behavioral finance thinking.

Table of contents

• Preface Central Tenet: The analysis of paradigm shifts provides a worthwhile means of thinking about capital structure decision making.
• 1. Introduction Central Tenet: “Why then do economists keep trying to develop models that assume rational behavior by firms?”—Merton Miller (1977)
• 2. Foundations—Is the Debt/Equity Decision Irrelevant? Central Tenet: Under MM (1958) assumptions including no taxes, the debt/equity decision is irrelevant.
• 3. Impact of Corporate Tax Central Tenet: With corporate taxes and no personal taxes, the optimum debt level shifts to 100 percent.
• 4. The Modifying Impact of Personal Taxes on Investors Central Tenet: With corporate and personal taxes, the optimum debt level shifts to one of two extremes—either 0 or 100 percent—but non-debt tax shields can move it to an interior optimum point.
• 5. Bankruptcy Cost’s Effect Central Tenet: With bankruptcy cost and taxes, the optimal debt-to-equity ratio will be at an interior point, not at an extreme point.
• 6. Effect of Agency Costs Central Tenet: With agency costs, bankruptcy costs, and taxes, the relationships become more complicated and the proportion of equity in the optimal capital structure increases.
• 7. Signaling Central Tenet: With signaling, agency costs, bankruptcy costs, and taxes, the relationships become contingent on the full set of firm characteristics.
• 8. Capital Structure as One of Many Simultaneously Determined Variables Central Tenet: The firm is a nexus of contracts. Capital structure decisions are made simultaneously with other decisions that can be solved by simultaneous equations to compute maximum firm value.
• 9. Executive Survey Interview Information Central Tenet: The current practice of capital structure decision making has considerable variation.
• 10. Current State of Research Frontier and Opportunities Central Tenet: The current state of research still leaves many questions unanswered.
• 11. Summary and Conclusions Central Tenet: The major capital structure decision factors are known, but the complexity remains largely unresolved.
• Appendixes
• Index