Optimal Capital Structure: An Option Theory Approach
NIEMINEN, MIKKO (2005)
2005
Kansantaloustiede - Economics
Kauppa- ja hallintotieteiden tiedekunta - Faculty of Economics and Administration
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Hyväksymispäivämäärä
2005-11-01
Julkaisun pysyvä osoite on
https://urn.fi/urn:nbn:fi:uta-1-15126
https://urn.fi/urn:nbn:fi:uta-1-15126
Tiivistelmä
Hakutermit:
tradeoff theory, costs of financial distress, tax shields, option valuation
The objective of this work is to introduce a model which is able to produce an optimal capital structure (OCS) for maximizing total firm value. The model is calibrated to reflect actual firm characteristics and uses contingent-claim methods to value tax shields and costs of financial distress associated with debt financing. It also maintains a long-run target debt to capital ratio by refinancing maturing debt; this provides a dynamic setting for capital structure choice. The model is derived from known financial theories and is theoretically consistent with other theories describing capital structure choice.
Several papers have emerged focusing on OCS with a variety of contingent-claim models. They all present similar characteristics concerning model calibration and the assumption of a tradeoff between tax shields and costs associated with leverage. However, the model presented in this in this work differs considerably from previous studies. The single most decisive factor is the valuation method of required returns on claims issued by a firm. Our model is entirely based on option theory and their pricing. The reason is that we are able to simultaneously incorporate several different factors which affect firm value within the capital structure choice. Another reason which makes option theory appealing is the fact that we are also able to extract market values and expected returns from within the model as they continuously alter accordingly to changes in leverage.
The model is derived from the earlier works of Black and Scholes (1973), Merton (1973) and Vassalou and Xing (2004). These papers as well as an introduction to option pricing theory and an over-all presentation of contemporary capital structure theories are revisited. We will produce some comparative static results which at first seem contradictory to earlier results and stipulations. However, while considering other capital structure theories, these findings provide new insight for maximizing firm value with optimal leverage. The empirical work focuses on the implications of our model and the results derived from Finnish companies during 19942003 period.
tradeoff theory, costs of financial distress, tax shields, option valuation
The objective of this work is to introduce a model which is able to produce an optimal capital structure (OCS) for maximizing total firm value. The model is calibrated to reflect actual firm characteristics and uses contingent-claim methods to value tax shields and costs of financial distress associated with debt financing. It also maintains a long-run target debt to capital ratio by refinancing maturing debt; this provides a dynamic setting for capital structure choice. The model is derived from known financial theories and is theoretically consistent with other theories describing capital structure choice.
Several papers have emerged focusing on OCS with a variety of contingent-claim models. They all present similar characteristics concerning model calibration and the assumption of a tradeoff between tax shields and costs associated with leverage. However, the model presented in this in this work differs considerably from previous studies. The single most decisive factor is the valuation method of required returns on claims issued by a firm. Our model is entirely based on option theory and their pricing. The reason is that we are able to simultaneously incorporate several different factors which affect firm value within the capital structure choice. Another reason which makes option theory appealing is the fact that we are also able to extract market values and expected returns from within the model as they continuously alter accordingly to changes in leverage.
The model is derived from the earlier works of Black and Scholes (1973), Merton (1973) and Vassalou and Xing (2004). These papers as well as an introduction to option pricing theory and an over-all presentation of contemporary capital structure theories are revisited. We will produce some comparative static results which at first seem contradictory to earlier results and stipulations. However, while considering other capital structure theories, these findings provide new insight for maximizing firm value with optimal leverage. The empirical work focuses on the implications of our model and the results derived from Finnish companies during 19942003 period.