Risk and the miller equilibrium: Capital structure choice with risk-averse investors

Abstract

Abstract. Merton Miller's (1977) tax model of equilibrium capital structure choice results in capital structure irrelevance and the existence of tax clienteles, assuming the restrictive case of risk-neutrality. Relaxation of the assumption of risk-neutrality in Miller's tax framework, allowing utility-maximizing risk-averse investors, indicates that capital structure irrelevance continues to hold under reasonable assumptions about utility. Evaluation of resulting tax clienteles shows that marginal tax rates do not restrict investors from investing in equities but do affect the tax status of purchased bonds.

Leverage versus volatility: Evidence from the capital structure of European firms

“…We extend the methodology of Vanessa Smith andTakashi Yamagata (2011) andcombine Whitelaw (1994), Brandt and Kang (2004), Pesaran et al (2004) and Dees et al (2007).…”

“…Nonetheless, in the absence of the tax deductibility, which is the case in only few countries in the world, the capital structure theory with risk-neutrality assumption (Smith and Conover, 1993), suggests that there is no benefit for borrowing. Accordingly, based on the assumption of risk-neutral market participants (Modigliani and Miller, 1958), firms would be indifferent to the source of capital if the cost of equity is less (or equal) compared to the cost of debt.…”