Post by Jules H Van Binsbergen on Feb 20, 2011 6:00:46 GMT 4
Optimal Capital Structure
Jules H. Van Binsbergen
Northwestern University - Kellogg School of Management; Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER)
John R. Graham
Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)
Jie Yang
Georgetown University - McDonough School of Business
January 18, 2011
Abstract:
We study optimal firm-specific capital structure for U.S. corporations. First, for each firm, we calculate the benefits of each dollar of interest tax deduction and summarize these in a "benefit of debt" function. The benefit function is downward sloping, reflecting the declining benefit of each incremental dollar of debt. Next, we use shifts in these benefit curves to identify the costs of using debt and summarize these in a "cost of debt" function. The cost function is increasing in the amount of debt a company uses and depends on firm characteristics such as the amount of collateral a firm has, firm size, the book-to-market ratio, intangible assets, cash flows, and whether a firm pays dividends. Third, for thousands of companies, our procedure produces a firm-specific recommendation of the optimal amount of debt the company should use. This optimal amount of debt occurs where the marginal benefit function intersects the marginal cost function. Any less (more) debt than optimal, and the benefits (costs) would outweigh the costs (benefits), indicating that the company is not maximizing firm value. We illustrate optimal debt choices for specific firms. Fourth, we calculate the cost of being under-levered for companies that use too little debt, and the cost of being over-levered for companies that use too much debt, and the net benefit of debt usage for those that are correctly levered. For some firms, the cost of being sub-optimally levered is small (implying that their capital structure decisions are of second-order importance), while for others the cost of operating sub-optimally is large. Finally, we provide formulas that can be easily used to approximate the cost of debt, and to determine the optimal amount of debt, for any given firm.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1743203_code650946.pdf?abstractid=1743203&mirid=2
Jules H. Van Binsbergen
Northwestern University - Kellogg School of Management; Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER)
John R. Graham
Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)
Jie Yang
Georgetown University - McDonough School of Business
January 18, 2011
Abstract:
We study optimal firm-specific capital structure for U.S. corporations. First, for each firm, we calculate the benefits of each dollar of interest tax deduction and summarize these in a "benefit of debt" function. The benefit function is downward sloping, reflecting the declining benefit of each incremental dollar of debt. Next, we use shifts in these benefit curves to identify the costs of using debt and summarize these in a "cost of debt" function. The cost function is increasing in the amount of debt a company uses and depends on firm characteristics such as the amount of collateral a firm has, firm size, the book-to-market ratio, intangible assets, cash flows, and whether a firm pays dividends. Third, for thousands of companies, our procedure produces a firm-specific recommendation of the optimal amount of debt the company should use. This optimal amount of debt occurs where the marginal benefit function intersects the marginal cost function. Any less (more) debt than optimal, and the benefits (costs) would outweigh the costs (benefits), indicating that the company is not maximizing firm value. We illustrate optimal debt choices for specific firms. Fourth, we calculate the cost of being under-levered for companies that use too little debt, and the cost of being over-levered for companies that use too much debt, and the net benefit of debt usage for those that are correctly levered. For some firms, the cost of being sub-optimally levered is small (implying that their capital structure decisions are of second-order importance), while for others the cost of operating sub-optimally is large. Finally, we provide formulas that can be easily used to approximate the cost of debt, and to determine the optimal amount of debt, for any given firm.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1743203_code650946.pdf?abstractid=1743203&mirid=2