Abstract
This paper revisits the Modigliani-Miller propositions on the optimal financing policy and cost of capital in a dynamic setting. In an environment without taxes and bankruptcy costs, the results are generally consistent with Modigliani and Miller Propositions 1 and 2. However, the first proposition should be presented and interpreted more carefully, as given firm characteristics, there is only one optimal capital structure. Thus, a firm's capital structure is relevant. A relaxation of assumptions about either taxes or bankruptcy costs leads to conclusions that are generally different from those in Modigliani and Miller (1958). The model predicts that leverage and sales-to-capital ratios decrease but firm size and capital stock increase with the subjective discount factor of the firm's manager if there are taxes and bankruptcy costs. The empirical analysis supports these predictions.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have