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Taxes and Corporate Capital Structure in an Incomplete Market

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  • Robert A. Taggart, Jr.

Abstract

This paper extends Merton Miller's 1977 analysis of corporate capital structure decisions to the incomplete capital markets case. As in Miller's model, aggregate demand for corporate leverage is curtailed as interest rates on taxable bonds rise. Unlike Miller's model, however, capital structure is not a matter of indifference to all equilibrium shareholders. Market incompleteness and tax arbitrage restrictions combine to prevent marginal rates of substitution from being equalized for all investors and hence their preferences are not unanimous. In addition, costs associated with debt induce a tendency for lower cost firms to issue a larger proportion of total corporate debt.

Suggested Citation

  • Robert A. Taggart, Jr., 1980. "Taxes and Corporate Capital Structure in an Incomplete Market," NBER Working Papers 0594, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0594
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    References listed on IDEAS

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    Cited by:

    1. Jones, C., 1999. "Miller's Equilibrium and Uncertainty," ANU Working Papers in Economics and Econometrics 1999-373, Australian National University, College of Business and Economics, School of Economics.
    2. Jongmoo Jay Choi & Frank J. Fabozzi & Uzi Yaari, 1989. "Optimum Corporate Leverage With Risky Debt: A Demand Approach," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 12(2), pages 129-142, June.
    3. Robert S. Chirinko & Stephen R. King, 1985. "Hidden Stimuli to Capital Formation: Debt and the Incomplete Adjustment of Financial Returns," NBER Working Papers 1684, National Bureau of Economic Research, Inc.
    4. Paul Grier & Paul Strebel, 1983. "An Implicit Clientele Test Of The Relationship Between Taxation And Capital Structure," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 6(2), pages 163-174, June.
    5. Lemma W. Senbet & Robert A. Taggart, Jr., 1981. "Capital Structure Equilibrium under Incomplete Market Conditions," NBER Working Papers 0747, National Bureau of Economic Research, Inc.
    6. T. Pham & D. Chow, 1989. "Some Estimates of Direct and Indirect Bankruptcy Costs in Australia: September 1978–May 1983," Australian Journal of Management, Australian School of Business, vol. 14(1), pages 75-95, June.
    7. Robert A. Taggart, Jr., 1981. "Secular Patterns in Corporate Finance," NBER Working Papers 0810, National Bureau of Economic Research, Inc.
    8. Robert L. McDonald, 1982. "Government Debt and Private Leverage: An Extension of the Miller Theorem," NBER Working Papers 0965, National Bureau of Economic Research, Inc.
    9. Moon Kim & Geoffrey Booth, 1985. "Yield Structure Of Taxable Vs. Nontaxable Bonds," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 8(2), pages 95-105, June.

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