Corporate Capital Structures in the United States (National by Benjamin M. Friedman (ed.)

By Benjamin M. Friedman (ed.)

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As long as agency costs cause equilibrium debt to be less than it would be if supply were perfectly elastic (that is, as long as B* is less than B* in fig. 10), the personal tax bracket, tpm, of the marginal bondholder at B* will be less than the corporate tax rate. Fig. 10 Effect of an increase in expected inflation in Miller model with no agency costs. 40 Robert A. Taggart, Jr. 1-tc r o 1-tc r'o r Fig. 11 S' o Effect of an increase in expected inflation in Miller model with agency costs. 11 shifts up by bdl{\ - tc) assuming that inflation is neutral with respect to the agency cost function.

Because of the way their incentive compensation scheme is set up, the firm's managers would be willing to pay a premium yield to substitute debt for equity up to this optimal point, but a negative premium beyond that point. The signaling model is thus diagrammatically identical to the agency cost model. As in the agency cost model, asset characteristics would play an important role in secular financing patterns, since firms' optimal capital structures depend on the range of asset qualities across firms and on investors' ability to distinguish among them.

An increase in expected inflation of A/, for example, will increase the tax-exempt bond rate demanded by investors by approximately A/. Investors in taxable securities, however, will demand that nominal rates rise sufficiently to maintain real after-tax yields. 24 The change in equilibrium corporate debt resulting from a change in expected inflation is given by (4) dB* di (l-tc)d[jr\/di The numerator may, in turn, be expressed as (5) - (1 - tc dr di dr0 di r2 39 Secular Patterns in the Financing of Corporations But, letting drldi = 1/(1 - tpm) and dro/di = 1 and recognizing that in equilibrium the marginal investor will be just indifferent between taxable and tax-exempt bonds, this numerator reduces to zero.

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