What Is the Major Source of Capital for Large Corporations

In: Business and Management

Submitted By aqwesi
Words 9981
Pages 40
Debt, Equity, and Taxes

By

Deen Kemsley* Columbia University and Yale University and Michael G. Williams** University of California, Los Angeles

January 10, 2002

We express appreciation for insightful comments from Antonio Bernardo, David Bradford, Roger Gordon, Larry Glosten, Rick Green, Glenn Hubbard, Jack Hughes, Michael Kirschenheiter, Stephen Penman, and workshop participants at the Columbia University Burton Conference and the Yale School of Management Faculty Workshop. Professor Kemsley also expresses appreciation for financial support from the Columbia Business School Research Program in Tax.
*

Correspondence Author: Yale School of Management, 135 Prospect Street, P.O. Box 208200, New Haven, CT 06520-8200, deen.kemsley@yale.edu, (203) 432-3780, fax: (212) 432-6974.
**

University of California at Los Angeles, Anderson Graduate School of Management, Box 9511481, Los Angeles, CA 90095-1481, (310) 825-4720, michael.williams@anderson.ucla.edu.

Debt, Equity, and Taxes Abstract
In this study, we extend Miller’s (1977) capital structure analysis by adding potentially high personal taxes on dividends and share repurchases, and by focusing on mature firms with at least some pre-existing equity. We demonstrate that personal taxes on equity distributions push new equity financing to an inferior corner, but they do not push internal equity (i.e., reinvested free cash flows) to a corner. Therefore an interior capital structure solution remains, in which firms are indifferent between using debt and internal equity financing, while preferring to avoid issuing additional external equity. Interestingly, many attributes of Miller’s model survive high personal taxes on equity distributions, including the aggregate debt-equity ratio, the identity of the marginal investment clientele, and investors’ portfolio allocations between debt and equity securities.…...

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