The Capital Structure Decision
In 1958 an academic paper on corporate finance written by two professors (Merton Miller and Frances Modigliani, who were later awarded the Nobel prize for their research efforts) was published in The American Economic Review. One prime conclusion of their
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THE CAPITAL STRUCTURE DECISION
by
Harold Bierman, Jr.
The Nicholas H. Noyes Professor of Business Administration The Johnson Graduate School of Management Cornell University Ithaca, New York
SPRINGER SCIENCE+BUSINESS MEDIA, LLC
The Capital Structure Decision; by Harold Bierman, Jr. ISBN 978-1-4613-5363-8 ISBN 978-1-4615-1037-6 (eBook) DOI 10.1007/978-1-4615-1037-6
Copyright C 2003 by Springer Science+Business Media New York Originally published by Kluwer Academic Publishers in 2003 Softcover reprint ofthe hardcover Ist edition 2003 AII rights reserved. No part of this work may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, microfilming, recording, ar otherwise, without the written permission from the Publisher, with the exception of any material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work. Permission for books published in Europe: [email protected] Permissions for books published in the United States of America: [email protected]
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Table of Contents Preface
vi
1.
Why Capital Structure is Important.
1
2.
Capital Structure Decision With Zero Taxes
.13
3.
Capital Structure Decision With Corporate Tax
.31
4.
Capital Structure Decision With Corporate and Investor Taxes
55
5.
Capital Structure Decision With Costs of Financial Distress
69
6.
Capital Structure Decision With Friendly and Unfriendly Debt.
75
7.
Capital Structure and Earnings Per Share
97
8.
Capital Structure and Capital Budgeting Decisions
9.
The Power of Tax Deductible Debt.
10.
Preferred Stock
143
11.
Convertible Bonds
161
12.
Leasing as a Method ofFinancing
I83
13.
Disparate Objectives
211
14.
An Overview
223
Index
115 .137
225
The Capital Structure Decision Preface The CFO of a major corporation was very proud of his decisionmaking. Over more than a decade the corporation had a very conservative capital structure (very little debt) and now that income was low, the viability ofthe firm was not threatened by debt claims. The wisdom ofthe conservative strategy was confIrmed. Or was it? This book looks at capital structure strategy and suggests that there are other goals attractive to common stockholders than the survival of the corporation. This point will be illustrated with examples. Diane Sherman has my appreciation for typing without complaint the many different drafts for many different books. Sy Smidt and Jerry Hass were, as ever, helpful colleagues.
Harold Bierman, Jr. Cornell University Ithaca, New York
Chapter 1 Why Capital Structure is Important A corporate financial officer who has conscientiously deciphered the academic literature to determine what decisions should be made relative to capital structure (the mixture of debt and equity fmancing) would have had an interes
