Inflation, Corporate Growth, and Corporate Leverage

Abstract

M The effect of inflation on firms' financing and investment decisions has been a recurring topic of analysis. Attention has been devoted to both the managerial implications and the security valuation consequences of broad-based upward movements in nominal product and factor-input prices.' A generally separate stream of research has dealt with the equilibrium rate of growth a corporation can sustain, given its operating characteristics.2 Because the two topic areas have only occasionally intersected, there are some influences of inflation on the investment opportunities and financial strategies of the growing firm that we feel have yet to be fully appreciated. We attempt to address those here. Our objectives are both pedagogical and analytical. We synthesize various elements of prior research and extend the content of that research, within a unified framework. The analysis is differentiated from previous literature by a more thorough treatment of the effects of the corporate income tax, asset turnover, fixed asset replacement requirements, and corporate debt and liquidity policies on sustainable growth. We thereby provide a more complete statement of the conditions under which inflation will preserve a firm's real growth opportunities. The potential implications of those conditions for the corporate leverage decision are then examined.