Title: Chapter 17 -- Capital Structure and Value
1Chapter 17 -- Capital Structure and Value
- Overview
- Perfect markets and capital structure irrelevance
- Influence on capital structure
- Information problems and capital structure
- Other considerations
- Empirical evidence on capital structure and value
2Perfect markets -- Modigliani and Miller
- No taxes, no bankruptcy, same information sets,
no transaction cost - Capital structure does not matter
- Shareholders will adjust the companys structure
to whatever they want
3Taxes and Capital Structure
- Differential tax rates
- Personal ordinary income rate
- What shareholders pay if they receive a dividend
- Corporate ordinary income rate
- What the corporation shares with the government
- Personal capital gains rate
- What you pay on the gain if you sell your stock
4Taxes and Capital Structure
- Differential tax rates within the corporation
- May have other tax shields such as depreciation
- May not have the income to pay taxes
5Bankruptcy or Liquidation cost and Capital
Structure
- Legal cost
- Disruption cost
- Expected bankruptcy cost and capital structure
6Information Problems Agency Cost
- Agency cost of debt
- Cost borne by your debt-holders to monitor your
actions or prospective actions - very low when debt is low but goes up as debt in
increased
7Information Problems Agency Costs
- Agency cost of equity
- Cost borne by shareholders to monitor your
actions - High with no debt but decreases as debt increases
- These cost decrease because
- others (debt-holders) are monitoring, often with
better information (monthly statements) - Cost of a loss is less with others participating
8Information Problems Agency Costs
- Look for the mixture of debt and equity that
minimizes total agency costs
9Information Problems Signaling
- Management may have a better information set than
the shareholders - Actions speak louder than words
- The assumption of debt signals managements
confidence in future cash flows - Issuing debt to buy back equity is a very
positive signal
10Other Considerations and Capital Structure Choice
- Unequal cost of corporate borrowing and personal
borrowing - This favors corporate borrowing over personal
borrowing
11Other Considerations and Capital Structure Choice
- Additional liability of homemade leverage
- Favors corporate over personal borrowing
- You can only lose the value of your stock
investment - With homemade leverage you can lose your personal
assets - Restrictions on homemade leverage
12Empirical Evidence on Capital Structure and Value
- As theories predict, taxes, bankruptcy costs, and
agency costs all have roles in determining
capital structure - Science is not so complete that we can predict or
prescribe the exact optimal capital structure