Abstract
This paper investigates whether the use of debt in the capital structure of a company is beneficial to its shareholders. It finds that, in the South African context, gearing has no effect on the value of a company. The use of debt can increase the value of a company in a country where capital profits and interest are taxed equally. This is the result of an interest tax shield, which is directly related to the tax deductibility of interest paid. However, when capital growth and dividends are exempt in the bands of investors, as is the case in South Africa, the interest tax shield does not exist, and there appears to be no benefit in increasing debt.
Highlights
INTRODUCflONIn 1958 Modigliani and Miller wrote an article to the affect that capital structure was not relevant to company value
This paper investigates whether the use of debt in the capital structure of a company is beneficial to its shareholders
This article investigates the benefit obtained from the use of debt in the capital structure of a company, focusing on the existence of an interest tax shield under South African tax legislation
Summary
In 1958 Modigliani and Miller wrote an article to the affect that capital structure was not relevant to company value. Modigliani and Miller amended their previous article (1963: 433-43) They demonstrated that due to the existence ofcompany taxation, there was an advantage attached to debt financing, which may be referred to as the interest tax shield. Research conducted by Cooley and Heck (1981: 23-33) amongst financial experts from different sectors of the fmancial and academic world in the USA, indicated that the Modigliani and Miller 1958 article should be regarded as the most significant contribution ever to fmance literature: 85% of 296 respondents included this article as one of the ten most significant contributions to finance literature This percentage was higher than for any other such contribution to fmance
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