Corporate Financial Policy, Taxation, and Macroeconomic Risk
This paper develops a simple model of corporate financial structure intended to formalize the macroeconomic concern over excessive leverage. In particular, we attempt to rationalize why firms designing an optimal capital structure would choose a level of debt that leaves them heavily exposed to macroeconomic risk. Our starting point is a variant of the "corporate control" model often used to motivate debt as the optimal financial contract. We modify this framework in two ways. First, we include common risks, interpretable as business cycle risks, as well as idiosyncratic risks. Second, we include corporate and investor-level taxes, and consider the implications of a net tax bias against equity finance. The tax distortion confronts firms with a tradeoff ex ante between the costs of equity finance and the costs of increased exposure to macroeconomic risk accompanying debt finance. In this regard, an equilibrium with "excessive leverage" is possible. Further, despite the possibility of renegotiation, debt is in general less effective than equity in insulating the firm against aggregate risk. Our model leads to the prediction that individual firm dividends may vary with macroeconomic conditions, even after controlling for the effects of relevant firm-specific performance measures, such as earnings. We present some formal econometric evidence in support of this prediction, using a panel of individual corporations. Evidence on some related predictions is also presented.
|Date of creation:||Nov 1991|
|Date of revision:|
|Publication status:||published as Rand Journal of Economics, 24 (Summer 1993), 286-303|
|Contact details of provider:|| Postal: |
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Marsh, Terry A & Merton, Robert C, 1987.
"Dividend Behavior for the Aggregate Stock Market,"
The Journal of Business,
University of Chicago Press, vol. 60(1), pages 1-40, January.
- Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
- Andrei Shleifer & Robert W. Vishny, 1991. "Asset Sales and Debt Capacity," NBER Working Papers 3618, National Bureau of Economic Research, Inc.
- Benjamin M. Friedman, 1986. "Increasing indebtedness and financial stability in the United States," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 27-61.
- Ben S. Bernanke & John Y. Campbell, 1988. "Is There a Corporate Debt Crisis?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 83-140.
- repec:fth:harver:1489 is not listed on IDEAS
- Mark J. Warshawsky, 1991. "Is There a Corporate Debt Crisis? Another Look," NBER Chapters, in: Financial Markets and Financial Crises, pages 207-230 National Bureau of Economic Research, Inc.
- Richard Cantor, 1990. "A panel study of the effects of leverage on investment and employment," Research Paper 9011, Federal Reserve Bank of New York.
- Mark Gertler & R. Glenn Hubbard, 1990.
"Taxation, Corporate Capital Structure, and Financial Distress,"
in: Tax Policy and the Economy: Volume 4, pages 43-72
National Bureau of Economic Research, Inc.
- Mark L. Gertler & R. Glenn Hubbard, 1989. "Taxation, Corporate Capital Structure, and Financial Distress," NBER Working Papers 3202, National Bureau of Economic Research, Inc.
- Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
- Michael C. Jensen, 1989.
"Active Investors, LBOs, and the Privatization of Bankruptcy,"
Journal of Applied Corporate Finance,
Morgan Stanley, vol. 2(1), pages 35-44.
- Michael C. Jensen, 2010. "Active Investors, LBOs, and the Privatization of Bankruptcy," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(1), pages 77-85.
- Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
- Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
- Easterbrook, Frank H, 1984. "Two Agency-Cost Explanations of Dividends," American Economic Review, American Economic Association, vol. 74(4), pages 650-59, September.
- James M. Poterba, 1987.
"Tax Policy and Corporate Saving,"
470, Massachusetts Institute of Technology (MIT), Department of Economics.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:3902. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.