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BANKRUPTCY COSTS: SOME EVIDENCE

BANKRUPTCY COSTS: SOME EVIDENCE M A Y 1n 9 SESSION TOPIC: CORPORATE FINANCE-EMPIRICAL SESSION CHAIRPERSON: MARTIN GRUBER* J. BANKRUPTCY COSTS: SOME EVIDENCE JEROLD WARNER** B. INTRODUCTION SUMMARY AND TESTS ASSUMPTIONS ABOUT THE magnitude of bankruptcy costs will have a considerable bearing on the issue of how much debt it is optimal for the firm to have in its capital structure. For example, in the original Modigliani-Miller model (1958), which abstracted from both corporate taxes and the possibility of bankruptcy, no debt/equity ratio could be regarded as optimal. Given perfect markets and rational investor behavior, they showed that the value of the firm would be invariant to its capital structure. Stiglitz (1969) has shown that the invariance result holds even when there is a positive probability of bankruptcy, but only as long as there are no transactions costs associated with bankruptcy.’ Relaxing the assumption that bankruptcy is costless and introducing a corporate tax in which interest payments can be deducted from net income reopens the possibility of optimal debt/equity ratios. Kraus and Litzenberger (1973) have developed a formal model dealing with this case, and on a more general level a central theme in textbook discussion of capital structure policy has become the presumed http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

BANKRUPTCY COSTS: SOME EVIDENCE

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References (14)

Publisher
Wiley
Copyright
1977 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
DOI
10.1111/j.1540-6261.1977.tb03274.x
Publisher site
See Article on Publisher Site

Abstract

M A Y 1n 9 SESSION TOPIC: CORPORATE FINANCE-EMPIRICAL SESSION CHAIRPERSON: MARTIN GRUBER* J. BANKRUPTCY COSTS: SOME EVIDENCE JEROLD WARNER** B. INTRODUCTION SUMMARY AND TESTS ASSUMPTIONS ABOUT THE magnitude of bankruptcy costs will have a considerable bearing on the issue of how much debt it is optimal for the firm to have in its capital structure. For example, in the original Modigliani-Miller model (1958), which abstracted from both corporate taxes and the possibility of bankruptcy, no debt/equity ratio could be regarded as optimal. Given perfect markets and rational investor behavior, they showed that the value of the firm would be invariant to its capital structure. Stiglitz (1969) has shown that the invariance result holds even when there is a positive probability of bankruptcy, but only as long as there are no transactions costs associated with bankruptcy.’ Relaxing the assumption that bankruptcy is costless and introducing a corporate tax in which interest payments can be deducted from net income reopens the possibility of optimal debt/equity ratios. Kraus and Litzenberger (1973) have developed a formal model dealing with this case, and on a more general level a central theme in textbook discussion of capital structure policy has become the presumed

Journal

The Journal of FinanceWiley

Published: May 1, 1977

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