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Taxation, Portfolio Choice, and Debt-Equity Ratios: A General Equilibrium Model

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  • Alan J. Auerbach
  • Mervyn A. King

Abstract

This paper explores the portfolio behavior of investors differing with respect to both tax rates and risk-aversion, emphasizing the role of constraints on individual and firm behavior in ensuring the existence of and characterizing portfolio equilibrium. Under certain conditions on the securities available in the market, which also are required for shareholders to be unanimous in supporting firm value maximization, investors will be segmented by tax rate into two groups, one specialized in equity and the other in debt. Though the relative wealths of the two groups determines the aggregate debt-equity ratio, each firm will be indifferent to its financial policy.

Suggested Citation

  • Alan J. Auerbach & Mervyn A. King, 1980. "Taxation, Portfolio Choice, and Debt-Equity Ratios: A General Equilibrium Model," NBER Working Papers 0546, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0546
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    1. Roger H. Gordon & David F. Bradford, 1980. "Taxation and the stock market valuation of capital gains and dividends : Theory and emphirical results," NBER Chapters,in: Econometric Studies in Public Finance, pages 109-136 National Bureau of Economic Research, Inc.
    2. Mervyn A. King, 1974. "Taxation and the Cost of Capital," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 21-35.
    3. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    4. Alan J. Auerbach & Mervyn A. King, 1979. "Corporate Financial Policy, Taxes, and Uncertainty: An Integration," NBER Working Papers 0324, National Bureau of Economic Research, Inc.
    5. Alan J. Auerbach, 1979. "Wealth Maximization and the Cost of Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 93(3), pages 433-446.
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