Some Aspects of the Pure Theory of Corporate Finance: Bankruptcies and Take-Overs: Reply

Joseph Eugène Stiglitz

252 citations0/0 files storedRePEc: Research Papers in Economics

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Corporate Finance and Governance Corporate Insolvency and Governance Financial Reporting and Valuation Research

Abstract

This paper reaffirms the earlier argument that when individuals differ in their expectations concerning the returns to investments, there will be an optimal debt-equity ratio, at a sufficiently high debt level. It assumes that in the judgment of lenders there is a finite probability of bankruptcy. The terms at which individuals as well as firms can borrow depends on their indebtedness and perceptions of potential lenders. Stapleton's analysis rests on the unacceptable assumption that individuals can borrow an arbitrary amount at the riskless rate, even though the firm in which they have all their wealth invested cannot. A new proof of the potentiality of productive inefficiency in the presence of bankruptcy is also presented.

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References

1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1958The Cost of Capital, Corporation Finance and the Theory of Investment 1921Risk, Uncertainty and Profit 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1966Equilibrium in a Capital Asset Market 1960Theory of Value: An Axiomatic Analysis of Economic Equilibrium 1978The Private and Social Value of Information and the Reward to Inventive Activity 1973The Role of Securities in the Optimal Allocation of Risk-bearing

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