Alfred Rappaport

Information inductance and its significance for accounting

Abstract Information inductance is the process whereby the behavior of an individual is affected by the information he is required to communicate. Inductance is seen to be a formally distinct, useful and necessary concept in its own right for an informational approach to the study of behavior in social systems. This is demonstrated by reference to the particular case of accounting information—both for internal reporting in the firm and the firms external reporting.

Debt Capacity, Optimal Capital Structure, and Capital Budgeting Analysis

* As far back as 1955, Solomon [9] recognized that capital budgeting decisions should consider the debtcarrying capacity that a proposed capital project adds to the firm. Since then, much work has been done on the nature of debt capacity and its value to the firm. The value of carrying debt was quantified by Modigliani and Miller (MM) [7] in the context of a competitive market with corporate taxes and no insolvency costs. Lewellen [5] further clarified the analysis of debt capacity by considering portfolio effects of an acquisition whose cash flows are less than perfectly correlated with those of the acquiring firm. Building on the MM framework and the capital asset pricing model, Bower and Jenks [1] explicitly incorporated the tax benefits of debt capacity in setting discount rates for individual projects. Martin and Scott [6] extended the Bower-Jenks analysis by expressing debt capacity in terms of a target probability risk of insolvency for the firm. The capital budgeting literature cited does not deal explicitly with the firms optimal capital structure. This paper seeks to do this and to analyze the implications of optimal structure in capital budgeting decisions.

Dividend Reinvestment, Price Appreciation and Capital Accumulation

Studies of historical stock market performance invariably focus on total shareholder return (TSR). Contrary to its name, TSR does not represent the return earned by equity investors but is instead the capital accumulation rate investors achieve if they purchase shares at the start date, reinvest all dividends to buy additional shares, and hold all shares to the terminal date. Investors who use historical TSR rates as a point of departure for establishing their assumed capital accumulation rates can be misled in two ways. First, because only the rare investor can afford to reinvest all dividends and sell no shares over a lifetime, the capital accumulation rate will almost always be lower than the TSR rate. Second, the remarkable historical growth in accumulated capital from reinvested dividends can mistakenly persuade some investors that dividends, rather than price appreciation, govern investment performance. Departures from 100% dividend reinvestment affect capital accumulation, and once investors make the dividend reinvestment decision, capital accumulation depends entirely on price appreciation.