Eli Talmor

The Value of the Tax Subsidy on Risky Debt

The effect of corporate taxes on the market value of a levered firm continues to be a central issue in recent contributions in finance theory (e.g., Miller 1977; DeAngelo and Masulis 1980; Kim 1982; Modigliani 1982). In these and other studies (e.g., Krause and Litzenberger 1973; Scott 1976; Brennan and Schwartz 1978; Kim 1978), the relationship between market value and capital structure is established by formulating a tax subsidy function that specifies the partial effect of debt on the expected tax savings at the corporate level under the existing U.S. tax code. A working assumption in most of these studies is that both principal and interest are tax deductible. This assumption is made in the spirit of the original Modigliani and Miller (1963) formulation in which debt is taken to be perpetual and riskless. Indeed, it is well known that the tax shield provided by the deduction of principal in a singleperiod framework has the same value as the tax shield from interest deductions in the case of perpetual and riskless debt. Under this assumption, it is shown that in the absence of non-debtThis paper examines the relationship between leverage and the value of the firm, when non-debt-related tax shields are available and the corporate tax is levied as an income tax. In a previous paper, De Angelo and Masulis argue that, in the presence of nondebt-related tax shields, the relationship between debt and firm value is concave, resulting in an interior optimal capital structure when there is a tax-induced differential in the cost of corporate debt. Their result derives from the fact that they assume the payment of debt principal and non-debt-related depreciation charges are deductible. However, the former deduction is consistent with a wealth tax, while the latter is consistent only with an income tax. We show that if the interest alone is deductible, the debt-firm value function is convex, resulting in corner solutions to the capital structure problem. * The authors wish to thank Richard Castanias, Richard Green, Lemma Senbet, and especially an anonymous referee for helpful comments, and Richard Green and Robert Dammon for computational assistance.

A Theory of Private Equity Turnarounds

This paper explores the advantage of private equity in turnaround situations. Since the analysis and recovery plan of floundering businesses is typically carried out by an external turnaround specialist, it is not clear what causes a breakdown in the ownership-management separation. The paper explores scenarios under which the transfer of ownership to private equity prior to implementing an operational turnaround can emerge as an optimal solution. Also considered is the possibility of investment syndication by which it the potential buyer can share the transaction with other private equity firms. Various alternatives are considered to approach the turnaround process, in particular, ones that allow for management replacement and others that do not.

Taxes and Dividend Policy

0 The 1986 tax act repealed the tax preference of realized capital gains over ordinary income. This has greatly reduced the tax disadvantage associated with dividend payments. Although several authors have noted that because capital gains can be deferred dividends may still be disadvantageous, the exact tax loss associated with dividend payments has not been analyzed.1 Here it will be demonstrated that if personal tax rates are constant over time, share repurchases have a tax advantage over dividends, regardless of the investors portfolio choice and even if realized capital gains are taxed at ordinary income rates. The analysis suggests that the magnitude of the tax benefit associated with share repurchases depends on the portfolio choice of the investor, particularly whether the investor whose shares are repurchased wishes to reinvest in the same security or in another one. The analysis also shows that when tax rates are not constant over time, there are certain situations in which dividends may be preferred to capital gains. These particular situations were common in the last two years, due to falling tax rates and the presence of large unrealized capital losses following the October 1987 stock market crash.

A Unified Analysis Of Executive Pay: The Case Of The Financial Sector

This study examines executive compensation determinants in the U.S. financial services sector. Multiple theories of executive pay are discussed and tested using a relatively homogenous sample. We perform an in-depth look at the corporate governance and ownership structure of the companies selected. The analysis is conducted for the financial sector as a whole and for each of three sub-groups: commercial banks, brokerage and other non-depository institutions, and insurance companies. Variables that proxy for managerial strategic discretion and task complexity are found to best explain CEO compensation. Corporate governance, including board characteristics and external ownership, is the second leading determinant of pay variation, while firm performance and CEO specific characteristics seem to play the least role. We explore the simultaneous relationship between compensation, firm performance, and board strength and find evidence that the board of directors provides a monitoring function and that a strong board appears to be a substitute with incentive compensation for aligning incentives. These findings, when viewed with subsequent firm performance, support an efficient contracting argument.

A mechanism design approach to transfer pricing by the multinational firm

Abstract This paper is about how multinationals choose transfer prices and optimal production levels in the presence of differential corporate income tax rates and local ownership requirements. A key featrure of the model is that there is an asymmetric information problem between a parent and its foreign subsidiary. We examine the interaction between ownership structure, corporate taxes and bargaining power. Transfer prices induce underproduction compared to the full-information case when the parent has the bargaining ability. When bargaining is controlled by the subsidiary, overproduction obtains. The model is used to illustrate how governmental objectives can be accomplished without direct regulation of the transfer price.

Do Customer Acquisition Cost, Retention and Usage Matter to Firm Performance and Valuation?

We examine the valuation role of customer acquisition cost, retention and usage in the wireless industry during the period 1997–2004. We develop and test a model that links customer acquisition cost, customer retention and call usage to future financial performance and valuation. In doing so, we control for the role of traditional accounting measures as predictors of firm performance. Although the wireless industry maintains a rapid pace of technological and commercial changes, fundamental accounting numbers are found to be value relevant. We provide new evidence that customer acquisition cost is likely a firm value driver. Specifically, we show that this cost is positively associated with customer retention, future profits and current market values. However, customer acquisition cost is not associated with future revenues, suggesting that successful investment in customer acquisition is capable of saving future expenses and hence of improving profitability. There does not seem to be a direct association between customer retention and usage. Nevertheless, we document a positive relation between retention and future revenues, as well as a positive association between usage and future profits. Collectively, these results suggest that retention and usage play an important mediating role linking customer acquisition with benefit generation. Consistent with this, we find some evidence that customer retention and usage enhance market values.

Managerial Bargaining Power in the Determination of Compensation Contracts and Corporate Investment

This paper considers the design of managerial compensation contracts and their impact on corporate investment decisions and the managerial effort decision. The model relates the compensation scheme to outside share ownership and managerial bargaining position. Using the methods of mechanism design under asymmetric information, a shift in favor of effort is documented in the case where managerial bargaining strength is weak, while a shift toward more use of capital investment results from strong managerial bargaining power. The model distinguishes managerial equity holdings from contingent compensation contracts. Our results are related to the empirical literature on pay-performance sensitivities. Copyright 1999 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Do Customer Acquisition Cost, Retention and Usage Matter to Firm Performance and Valuation?: CUSTOMER ACQUISITION COST, FIRM PERFORMANCE AND VALUATION

We examine the valuation role of customer acquisition cost, retention and usage in the wireless industry during the period 1997-2004. We develop and test a model that links customer acquisition cost, customer retention and call usage to future financial performance and valuation. In doing so, we control for the role of traditional accounting measures as predictors of firm performance. Although the wireless industry maintains a rapid pace of technological and commercial changes, fundamental accounting numbers are found to be value relevant. We provide new evidence that customer acquisition cost is likely a firm value driver. Specifically, we show that this cost is positively associated with customer retention, future profits and current market values. However, customer acquisition cost is not associated with future revenues, suggesting that successful investment in customer acquisition is capable of saving future expenses and hence of improving profitability. There does not seem to be a direct association between customer retention and usage. Nevertheless, we document a positive relation between retention and future revenues, as well as a positive association between usage and future profits. Collectively, these results suggest that retention and usage play an important mediating role linking customer acquisition with benefit generation. Consistent with this, we find some evidence that customer retention and usage enhance market values.

Debt and taxes: A multiperiod investigation☆

Abstract This paper extends the Miller bond market equilibrium analysis to a multiperiod setting. From the model developed we derive several predictions relating optimal financial leverage to firm characteristics and to the business cycle. The analysis also reveals some interesting determinants of the market value of the tax subsidy associated with corporate debt.

Tax arbitrage restrictions and financial leverage clienteles

Abstract This paper argues that while total short sale constraints are often introduced to rule out tax arbitrage, such constraints are both unrealistic and conceptually problematic. Instead, milder constraints are advocated, which prevent tax arbitrage while still allow short positions. It is demonstrated that a model with these constraints employed can support bond pricing as in the Miller equilibrium, although it leads to a richer set of tax clienteles.