Presence Of Taxes Research Articles

A Reexamination of the Empirical Relationship Between Investment and Financing Decisions

Several studies (see [7], [15], [9], and [16]) have attempted to ascertain the empirical relationships that exist between the financing and investment decisions of firms. The primary impetus for these efforts was provided by Modigliani and Miller (MM) [20], [21] when they demonstrated that under the assumption of perfect capital markets, the optimal investment decisions of a firm are separable from its financing decisions. In the presence of market imperfections, interdependencies between these decisions that violate the basic MM propositions may exist. Therefore, the studies referred to above have essentially focused upon determining whether market imperfections have been of sufficient magnitude to lead to joint determination of investment and financing decisions. Though the original MM propositions were introduced more than two decades ago, the nature of the empirical relationship between investment and financing decisions remains a controversial issue. The fact that this matter is still unresolved is not attributable to a lack of attention, for the original propositions have been examined in the presence of taxes, bankruptcy costs, and agency costs with no clear consensus emerging.

A Simple Scheme for Estimating an Intertemporal Model of Labor Supply and Consumption in the Presence of Taxes and Uncertainty

A Simple Scheme for Estimating an Intertemporal Model of Labor Supply and Consumption in the Presence of Taxes and Uncertainty

THE INSIGNIFICANCE OF BANKRUPTCY COSTS TO THE THEORY OF OPTIMAL CAPITAL STRUCTURE

IN THEIR PATHBREAKING PAPER some 20 years ago, Modigliani and Miller (MM) demonstrated the irrelevance of capital structure to the value of the firm in a taxless world. Their later article (1963) correctly accounts for the effect of taxes and proves that debt financing increases the value of the firm through what effectively amounts to a government subsidy. Several recent studies have replicated the MM results under less restrictive conditions [Baron (1974), Stiglitz (1969, 1974), etc.]. In particular, these studies have demonstrated that the MM thesis is intact even in the presence of a positive probability of costless bankruptcy. The more general proof of this is provided by Stiglitz (1974) who invokes a costless financial intermediary that can reconstitute the firm which alters its debt-equity ratio. That is, the value of the firm must be unrelated to capital structure so long as a costless financial intermediary can be established to maintain the opportunity set facing individual investors. Under this framework, Stiglitz proves that the finite probability of costless bankruptcy has no effect on the value of the firm. Although the original MM results can be obtained under more general conditions, their theorem in the presence of taxes is troublesome, since it implies the near exclusion of equity financing (or equivalently, a nearly infinite debt-equity ratio). However, a number of authors [e.g., Baxter (1967), Hirshleifer (1970, p. 264)] have noted that bankruptcy costs may provide an economic rationale for the existence of a finite, optimal capital structure, and hence provide a reconciliation between the MM theorem and observed firm behavior. More recently, others [Kraus and Litzenberger (1973), Scott (1976), Kim (1976), etc.] have formally introduced bankruptcy costs in their models. These authors claim that an optimal, finite debt-equity ratio can exist, resulting from a trade-off between the expected value of bankruptcy costs and the tax savings associated with the deductibility of interest payments. Essentially, the optimum is reached when the present value of the

A Simulation Experiment into the Numerical Properties of General Equilibrium Models of Factor Market Distortions

HOW big are static efficiency losses from market distortions? How do these loss estimates vary with the size of distortions? How are the effects of distortions compounded (or offset) when more than one distortion occurs? How do efficiency loss estimates vary with the parameters of a model for given distortions? How are efficiency loss estimates affected by the level of aggregation within a model? These questions all require quantitative answers which have, until recently, been difficult to obtain due to the absence of adequate computational devices for analysing them. This paper reports some numerical results which have a bearing on the questions posed above. Fixed point computational techniques are applied to some simple general equilibrium models often used in economics but whose numerical properties are less well known. The techniques which are used derive from some recent proposals by Shoven and Whalley (1973) for procedures for the computation of competitive equilibria in the presence of taxation. These, in turn, build on the fundamental work in this field due to Scarf (1973). The main focus is the two industry general equilibrium literature on factor market distortions that has developed from the work of Harberger (1966) and Johnson (1966) (see the survey article by Magee (1973)). In this paper a process of repeated solution for competitive equilibria in the presence of factor market distortions is followed for different parametric values of coefficients and distortions. Results are reported for a number of cases of interest, and a final section attempts to synthesize results into some broad conclusions on numerical properties of these models. Even though these formulations are themselves oversimplified representations of economic processes, it seems useful to investigate possible rules of thumb for simple models which can be appealed to in more complex policy situations.