第十六章 资本结构：债务的运用

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1. Chapter Outline16.1 Costs of Financial Distress 16.2 Description of Costs 16.3 Can Costs of Debt Be Reduced? 16.4 Integration of Tax Effects and Financial Distress Costs 16.5 Shirking, Perquisites, and Bad Investments: A Note on Agency Cost of Equity 16.6 The Pecking-Order Theory 16.7 Growth and the Debt-Equity Ratio 16.8 Personal Taxes 16.9 How Firms Establish Capital Structure 16.10 Summary and Conclusions
2. 16.1 Costs of Financial DistressBankruptcy risk versus bankruptcy cost. The possibility of bankruptcy has a negative effect on the value of the firm. However, it is not the risk of bankruptcy itself that lowers value. Rather it is the costs associated with bankruptcy. It is the stockholders who bear these costs.
3. 16.2 Description of CostsDirect Costs Legal and administrative costs (tend to be a small percentage of firm value). Indirect Costs Impaired ability to conduct business (e.g., lost sales) Agency Costs Selfish strategy 1: Incentive to take large risks Selfish strategy 2: Incentive toward underinvestment Selfish Strategy 3: Milking the property
4. Balance Sheet for a Company in DistressAssets BV MV Liabilities BV MV Cash $200 $200 LT bonds $300 Fixed Asset $400 $0 Equity $300 Total $600 $200 Total $600 $200 What happens if the firm is liquidated today?The bondholders get $200; the shareholders get nothing.$200$0
5. Selfish Strategy 1: Take Large RisksThe Gamble Probability Payoff Win Big 10% $1,000 Lose Big 90% $0 Cost of investment is $200 (all the firm’s cash) Required return is 50% Expected CF from the Gamble = $1000 × 0.10 + $0 = $100
6. Selfish Stockholders Accept Negative NPV Project with Large RisksExpected CF from the Gamble To Bondholders = $300 × 0.10 + $0 = $30 To Stockholders = ($1000 - $300) × 0.10 + $0 = $70 PV of Bonds Without the Gamble = $200 PV of Stocks Without the Gamble = $0 PV of Bonds With the Gamble = $30 / 1.5 = $20 PV of Stocks With the Gamble = $70 / 1.5 = $47
7. Selfish Strategy 2: UnderinvestmentConsider a government-sponsored project that guarantees $350 in one period Cost of investment is $300 (the firm only has $200 now) so the stockholders will have to supply an additional $100 to finance the project Required return is 10%Should we accept or reject?
8. Selfish Stockholders Forego Positive NPV ProjectExpected CF from the government sponsored project: To Bondholder = $300 To Stockholder = ($350 - $300) = $50 PV of Bonds Without the Project = $200 PV of Stocks Without the Project = $0 PV of Bonds With the Project = $300 / 1.1 = $272.73 PV of Stocks with the project = $50 / 1.1 - $100 = -$54.55
9. Selfish Strategy 3: Milking the PropertyLiquidating dividends Suppose our firm paid out a $200 dividend to the shareholders. This leaves the firm insolvent, with nothing for the bondholders, but plenty for the former shareholders. Such tactics often violate bond indentures. Increase perquisites to shareholders and/or management
10. 16.3 Can Costs of Debt Be Reduced?Protective Covenants Debt Consolidation: If we minimize the number of parties, contracting costs fall.
11. Protective CovenantsAgreements to protect bondholders Negative covenant: Thou shalt not: Pay dividends beyond specified amount. Sell more senior debt & amount of new debt is limited. Refund existing bond issue with new bonds paying lower interest rate. Buy another company’s bonds. Positive covenant: Thou shall: Use proceeds from sale of assets for other assets. Allow redemption in event of merger or spinoff. Maintain good condition of assets. Provide audited financial information.
12. 16.4 Integration of Tax Effects and Financial Distress CostsThere is a trade-off between the tax advantage of debt and the costs of financial distress. It is difficult to express this with a precise and rigorous formula.
13. Integration of Tax Effects and Financial Distress CostsDebt (B)Value of firm (V)0Present value of taxshield on debtPresent value offinancial distress costsValue of firm underMM with corporatetaxes and debtVL = VU + TCBV = Actual value of firmVU = Value of firm with no debtB*Maximumfirm valueOptimal amount of debt
14. The Pie Model RevisitedTaxes and bankruptcy costs can be viewed as just another claim on the cash flows of the firm. Let G and L stand for payments to the government and bankruptcy lawyers, respectively. VT = S + B + G + L The essence of the M&M intuition is that VT depends on the cash flow of the firm; capital structure just slices the pie.SGBL
15. 16.5 Shirking, Perquisites, and Bad Investments: The Agency Cost of EquityAn individual will work harder for a firm if he is one of the owners than if he is one of the “hired help”. Who bears the burden of these agency costs? While managers may have motive to partake in perquisites, they also need opportunity. Free cash flow provides this opportunity. The free cash flow hypothesis says that an increase in dividends should benefit the stockholders by reducing the ability of managers to pursue wasteful activities. The free cash flow hypothesis also argues that an increase in debt will reduce the ability of managers to pursue wasteful activities more effectively than dividend increases.
16. 16.6 The Pecking-Order TheoryTheory stating that firms prefer to issue debt rather than equity if internal finance is insufficient. Rule 1 Use internal financing first. Rule 2 Issue debt next, equity last. The pecking-order Theory is at odds with the trade-off theory: There is no target D/E ratio. Profitable firms use less debt. Companies like financial slack
17. 16.7 Growth and the Debt-Equity RatioGrowth implies significant equity financing, even in a world with low bankruptcy costs. Thus, high-growth firms will have lower debt ratios than low-growth firms. Growth is an essential feature of the real world; as a result, 100% debt financing is sub-optimal.
18. 16.8 Personal Taxes: The Miller ModelThe Miller Model shows that the value of a levered firm can be expressed in terms of an unlevered firm as:Where: TS = personal tax rate on equity income TB = personal tax rate on bond income TC = corporate tax rate
19. Personal Taxes: The Miller ModelThe derivation is straightforward:Continued…
20. Personal Taxes: The Miller Model (cont.)The first term is the cash flow of an unlevered firm after all taxes. Its value = VU. A bond is worth B. It promises to pay rBB×(1- TB) after taxes. Thus the value of the second term is:The total cash flow to all stakeholders in the levered firm is:The value of the sum of these two terms must be VL
21. Personal Taxes: The Miller Model (cont.)Thus the Miller Model shows that the value of a levered firm can be expressed in terms of an unlevered firm as:In the case where TB = TS, we return to M&M with only corporate tax:
22. Effect of Financial Leverage on Firm Value with Both Corporate and Personal TaxesDebt (B)Value of firm (V)VUVL = VU+TCB when TS =TBVL < VU + TCBwhen TS < TB but (1-TB) > (1-TC)×(1-TS)VL =VU when (1-TB) = (1-TC)×(1-TS)VL < VU when (1-TB) < (1-TC)×(1-TS)
23. Integration of Personal and Corporate Tax Effects and Financial Distress Costs and Agency CostsDebt (B)Value of firm (V)0Present value of taxshield on debtPresent value offinancial distress costsValue of firm underMM with corporatetaxes and debtVL = VU + TCBV = Actual value of firmVU = Value of firm with no debtB*Maximumfirm valueOptimal amount of debtVL < VU + TCBwhen TS < TB but (1-TB) > (1-TC)×(1-TS)Agency Cost of EquityAgency Cost of Debt
24. 16.9 How Firms Establish Capital StructureMost Corporations Have Low Debt-Asset Ratios. Changes in Financial Leverage Affect Firm Value. Stock price increases with increases in leverage and vice-versa; this is consistent with M&M with taxes. Another interpretation is that firms signal good news when they lever up. There are Differences in Capital Structure Across Industries. There is evidence that firms behave as if they had a target Debt to Equity ratio.
25. Factors in Target D/E RatioTaxes If corporate tax rates are higher than bondholder tax rates, there is an advantage to debt. Types of Assets The costs of financial distress depend on the types of assets the firm has. Uncertainty of Operating Income Even without debt, firms with uncertain operating income have high probability of experiencing financial distress. Pecking Order and Financial Slack Theory stating that firms prefer to issue debt rather than equity if internal finance is insufficient.
26. 16.10 Summary and ConclusionsCosts of financial distress cause firms to restrain their issuance of debt. Direct costs Lawyers’ and accountants’ fees Indirect Costs Impaired ability to conduct business Incentives to take on risky projects Incentives to underinvest Incentive to milk the property Three techniques to reduce these costs are: Protective covenants Repurchase of debt prior to bankruptcy Consolidation of debt
27. 16.10 Summary and ConclusionsBecause costs of financial distress can be reduced but not eliminated, firms will not finance entirely with debt.Debt (B)Value of firm (V)0Present value of taxshield on debtPresent value offinancial distress costsValue of firm underMM with corporatetaxes and debtVL = VU + TCBV = Actual value of firmVU = Value of firm with no debtB*Maximumfirm valueOptimal amount of debt
28. 16.10 Summary and ConclusionsIf distributions to equity holders are taxed at a lower effective personal tax rate than interest, the tax advantage to debt at the corporate level is partially offset. In fact, the corporate advantage to debt is eliminated if (1-TC) × (1-TS) = (1-TB) Debt (B)Value of firm (V)0Present value of taxshield on debtPresent value offinancial distress costsValue of firm underMM with corporatetaxes and debtVL = VU + TCBV = Actual value of firmVU = Value of firm with no debtB*Maximumfirm valueOptimal amount of debtVL < VU + TCB when TS < TB but (1-TB) > (1-TC)×(1-TS)Agency Cost of EquityAgency Cost of Debt
29. 16.10 Summary and ConclusionsDebt-to-equity ratios vary across industries. Factors in Target D/E Ratio Taxes If corporate tax rates are higher than bondholder tax rates, there is an advantage to debt. Types of Assets The costs of financial distress depend on the types of assets the firm has. Uncertainty of Operating Income Even without debt, firms with uncertain operating income have high probability of experiencing financial distress.