Government as the Firm’s Third Financial Stakeholder: Impact on Capital Investment Decisions, Capital Structure, Discount Rates, and Valuation

Ronald Spahr, Fariz Huseynov and Pankaj Jain

The Engineering Economist, 2012, vol. 57, issue 3, 157-177

Abstract: We extend Myers’ (1974) adjusted present value method and modify Modigliani and Miller's (1958, 1963) capital structure propositions by adding government as the firms’ third major financial stakeholder. Government is a major stakeholder because it collects income taxes, is instrumental in establishing the business environment, and provides business infrastructure to corporations. We assume that government's stake is an implicit form of capital and, consequently, any return or benefit derived by the firm from this implicit capital will affect firm value. As a result, tax structure significantly impacts relative stakeholder values, capital investment decisions, and capital formation. Only in the special case when the firm receives explicit benefits and when the return on government's implicit capital is equal to the firm's cost of equity capital will corporate taxes not impact firm value and capital investment decisions. Although tax irrelevance and the conservation of value principle may hold true within a domestic economy with a homogenous tax structure, our three-stakeholder model demonstrates that corporate income taxes become relevant for investment decisions in a globally competitive economy with heterogeneous tax structures. Thus, our model addresses the apparent inconsistencies between existing theory, which characterizes corporate taxes as nondistortionary, and empirical findings, which demonstrate that taxes reduce investments, growth, and valuation ratios.

Date: 2012
References: Add references at CitEc
Citations:

Downloads: (external link)
http://hdl.handle.net/10.1080/0013791X.2012.703762 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:uteexx:v:57:y:2012:i:3:p:157-177

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/UTEE20

DOI: 10.1080/0013791X.2012.703762

Access Statistics for this article

The Engineering Economist is currently edited by Sarah Ryan

More articles in The Engineering Economist from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().