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The Equity Trap, the Cost of Capital and the Firm’s Growth Path

  • Tobias Lindhe
  • Jan Södersten

This paper reconsiders Sinn’s (1991) nucleus theory of the corporation by comparing two different regimes for the equity trap. In the first of these, all cash paid to the shareholders is taxed as dividends, in the second, shareholders are allowed a tax-free return of capital contributed through new issues. A substantial difference is found between the regimes in the size of initial equity injections, although in both regimes, no dividends are paid until a new long-run equilibrium is reached. Contrary to Sinn, we find that with optimal behavior, the cost of new equity is lower than suggested by conventional formulae.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2006/wp-cesifo-2006-09/cesifo1_wp1801.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1801.

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Date of creation: 2006
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Handle: RePEc:ces:ceswps:_1801
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  1. Alan J. Auerbach, 1982. "Taxation, Corporate Financial Policy and the Cost of Capital," NBER Working Papers 1026, National Bureau of Economic Research, Inc.
  2. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers 0349, National Bureau of Economic Research, Inc.
  3. Alan J. Auerbach, 2001. "Taxation and Corporate Financial Policy," NBER Working Papers 8203, National Bureau of Economic Research, Inc.
  4. Sinn, Hans-Werner, 1991. "The vanishing harberger triangle," Munich Reprints in Economics 19842, University of Munich, Department of Economics.
  5. Alan J. Auerbach, 1980. "Wealth Maximization and the Cost of Capital," NBER Working Papers 0254, National Bureau of Economic Research, Inc.
  6. Auerbach, Alan J. & Hassett, Kevin A., 2003. "On the marginal source of investment funds," Journal of Public Economics, Elsevier, vol. 87(1), pages 205-232, January.
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