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Taxes and Corporate Capital Structure in an Incomplete Market

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  • Robert A. Taggart, Jr.
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    Abstract

    This paper extends Merton Miller's 1977 analysis of corporate capital structure decisions to the incomplete capital markets case. As in Miller's model, aggregate demand for corporate leverage is curtailed as interest rates on taxable bonds rise. Unlike Miller's model, however, capital structure is not a matter of indifference to all equilibrium shareholders. Market incompleteness and tax arbitrage restrictions combine to prevent marginal rates of substitution from being equalized for all investors and hence their preferences are not unanimous. In addition, costs associated with debt induce a tendency for lower cost firms to issue a larger proportion of total corporate debt.

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    File URL: http://www.nber.org/papers/w0594.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0594.

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    Date of creation: Dec 1980
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    Handle: RePEc:nbr:nberwo:0594

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    1. Han Kim, E. & Lewellen, Wilbur G. & McConnell, John J., 1979. "Financial leverage clienteles : Theory and evidence," Journal of Financial Economics, Elsevier, vol. 7(1), pages 83-109, March.
    2. Brenner, Menachem & Subrahmanyam, Marti G, 1977. "Intra-Equilibrium and Inter-Equilibrium Analysis in Capital Market Theory: A Clarification," Journal of Finance, American Finance Association, vol. 32(4), pages 1313-19, September.
    3. Litzenberger, Robert H & Sosin, Howard B, 1977. "The Theory of Recapitalizations and the Evidence of Dual Purpose Funds," Journal of Finance, American Finance Association, vol. 32(5), pages 1433-55, December.
    4. Haugen, Robert A & Senbet, Lemma W, 1978. "The Insignificance of Bankruptcy Costs to the Theory of Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 33(2), pages 383-93, May.
    5. Robichek, Alexander A. & Myers, Stewart C., 1966. "Problems in the Theory of Optimal Capital Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 1(02), pages 1-35, June.
    6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    7. Stiglitz, Joseph E., 1973. "Taxation, corporate financial policy, and the cost of capital," Journal of Public Economics, Elsevier, vol. 2(1), pages 1-34, February.
    8. Ferri, Michael G & Jones, Wesley H, 1979. "Determinants of Financial Structure: A New Methodological Approach," Journal of Finance, American Finance Association, vol. 34(3), pages 631-44, June.
    9. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
    10. Grossman, Sanford J & Stiglitz, Joseph E, 1977. "On Value Maximization and Alternative Objectives of the Firm," Journal of Finance, American Finance Association, vol. 32(2), pages 389-402, May.
    11. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
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    Cited by:
    1. Jones, C., 1999. "Miller's Equilibrium and Uncertainty," ANU Working Papers in Economics and Econometrics 1999-373, Australian National University, College of Business and Economics, School of Economics.
    2. Robert L. McDonald, 1984. "Government Debt and Private Leverage: An Extension of the Miller Theorem," NBER Working Papers 0965, National Bureau of Economic Research, Inc.
    3. Lemma W. Senbet & Robert A. Taggart, Jr., 1984. "Capital Structure Equilibrium under Incomplete Market Conditions," NBER Working Papers 0747, National Bureau of Economic Research, Inc.

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