Myron J. Gordon

Finance, investment and macroeconomics : the neoclassical and a post Keynesian solution

This work advances a theory of finance and investment under uncertainty and risk aversion which resolves problems left unsolved by Keynes in a manner consistent with his work. Keynes established that both the short-run and long-run performance of a capitalist system depend upon investment, but he failed to arrive at an alternative to the neoclassical theory of investment. Professor Gordon demonstrates that the extension of neoclassical theory to deal with uncertainty and risk aversion is based upon a string of assumptions which are empirically false. The competitive stationary state, the foundation for the neoclassical theory of a capitalist system, is shown to be unfeasible because it results in a very high probability of bankruptcy at the micro level and the systems early collapse on the macro level. Capitalists seeking long term survival are shown to be subject to a growth imperative, to the pursuit of monopoly power, and to a concern for financial policy. Later sections of the book discuss the consequences of this behaviour for short-run fluctuations and the long-run development of capitalist systems. This book advanves a new theory of finance and investment which recognizes the problem of bankruptcy when the future is uncertain. It should be of use to both post-Keynesian and neoclassical economists as a significant contribution to economic understanding.

The pricing of risk in common shares

The capital asset pricing model predicts positive correlation between the expected return on a share and its systematic risk or beta. A number of papers in which some variant on average realized holding period return is used as a proxy for expected returns finds no significant correlation between the variables. These results cast doubt on the fundamental theorem of finance, that investors price risk. This paper uses a better estimate of expected return, and the data provides strong evidence that investors price risk. In addition the relation between beta and other risk variables is clarified.

The real income and consumption of an Urban Chinese family

This study estimates for 1989 the cost in Canada of the products and services consumed by a representative urban Chinese family in the second highest income quintile. The ratio of this figure, called the purchasing power parity cost, to the figure obtained by converting the yuan cost of the consumption to dollars at the exchange rate was 10.5. This ratio is very much higher than the ratio for other underdeveloped countries, and reasons for the difference are examined.

Is China's financial system threatened by its policy loans debt?

Abstract Policy loans in China were made to unprofitable state enterprises, thereby avoiding bankruptcy for the enterprises and unemployment for theirs workers. Policy loans outstanding reached a very large fraction of all loans outstanding and of GNP. In the west, the business press and many academics claimed that this debt threatened the banking system and the entire economy, while Chinese economists expressed no such fear. They only called for an early end to more policy loans and to modernization of the banking systems. This paper reviews the history of policy loans and then explains why their outstanding amount, large as it is, poses absolutely no threat of a financial crisis for China. There could be a crisis, only if joining the WTO and becoming integrated into the international financial community persuades China to make its private and business wealth freely convertible into dollars.

Leverage and the value of a firm under a progressive personal income tax

The relation between a firms value and its leverage rate is investigated under a tax regime where interest is a tax-deductible expense to firms, where it is taxed at a progressive rate to persons, and where share income is free of taxation. The analysis is restricted to a one-period economy with capital markets that are perfectly competitive apart from the above tax regime. The equilibrium value of a firm is found to be a convex function of its leverage rate. It is independent of the leverage rate only in the special case where the portfolio decisions of persons make all their marginal tax rates the same and equal to the corporate tax rate.

A Contribution to the Micro Foundation for Keynesian Macroeconomic Models

The levels of employment and output in Keynesian macroeconomic models depend materially on the macro consequences of consumption and investment decisions at the micro level. There is considerable literature on how these decisions are made by portfolio investors, but it provides a wide range of solutions that depend upon the assumptions with regard to the investor’s consumption utility function and the treatment of bankruptcy. This chapter uses economic considerations to rule out those solutions which would seem to have little relevance for the macro behavior of consumption and investment. The most important feature of the remaining solutions is that the fraction of net worth consumed and the fraction invested in a risky portfolio both decline as net worth increases.

The methodology of finance: A round table discussion

Abstract This round table discussion on “The Methodology of Finance” took place in St. Louis, during the annual meeting of the Financial Management Association. The moderator was George M. Frankfurter [GF] and the panel participants, in alphabetical order, were: Willard Carleton [BC], University of Arizona; Myron Gordon [MG], The University of Toronto; James Horrigan [JH], The University of New Hampshire; Elton McGoun [EM], Bucknell University; George Philippatos [GP], The University of Tennessee; and Chris Robinson [CR], York University.

The Interest Rate Component of Systematic Risk

Changes in the long-term interest rate would seem to be an important source of systematic risk for common shares, but the empirical results to date have been very disappointing. For the most part these results have been obtained with a model where an interest rate variable, say the holding period return (HPR) on a long bond, is added to the market model. This paper examines two alternative models in which the independent variables are different linear combinations of the HPRs on the market and a long bond. The alternative models are found to be superior theoretically and empirically. In tests on a large number of utility and industrial shares over a number of periods, the most attractive model theoretically produces interest rate betas that are highly significant for all utility shares and a very large fraction of the industrial shares.

Leverage and the value of a firm under a progressive personal income tax Reply

In his ‘Debt and Taxes’ Miller argued that the value of a firm is independent of its leverage rate and each firms leverage rate is therefore indeterminate. My paper showed that under the Miller assumptions the value of a firm is a convex function of its leverage rate, and all value-maximizing firms would be at the maximum leverge rate. The Jaffe and Westerfield extension of my analysis established the conditions under which some firms would be at a zero leverage rate. Their analysis does not lead to their statement that ‘the firms value is invariant to the debt-equity ratio’.

OPTIMAL TIMING OF CAPITAL EXPENDITURES

Publisher Summary This chapter presents a model for determining whether investment expenditure should be made currently or deferred for one or more periods. The failure of business practice to use the models already developed cannot be explained on the grounds that the problem is of little importance. It is seen that ignoring the alternative of deferring expenditure one or more periods introduces significant error in capital expenditure decisions. Furthermore, with capital rationing a firm does not decide which of its profitable projects it should reject. Rather, it decides which of the projects should be deferred. In practice, business firms frequently use qualitative judgements or crude rules of thumb to recognize the timing alternatives open to them. A more reasonable explanation of business practice is that the models are difficult to understand and/or the data required to implement them are difficult to obtain with any reasonable degree of accuracy. Either state of affairs can result in worse decisions based on a formally accurate model than would take place with crude but familiar and roughly correct rules of thumb.