Capital Structure Theory and the Fisher Effect

Kelly, William A, and James A Miles

The Financial Review, 1989, vol. 24, issue 1, 53-73

Abstract: This paper incorporates capital structure theory to model the response of nominal interest rates to expected inflation in a world with taxes. Within an otherwise common framework, the model includes Modigliani-Miller and Miller capital structure theory, as well as a variation of the Miller model with bankruptcy costs developed by DeAngelo and Masulis. Within this framework, the authors derive an equation to predict the response of nominal interest rates under each capital structure hypothesis. With Modigliani-Miller theory, the model predicts di(superscript)D/d$ values consistent with empirically observed ranges. With Miller theory, the predictions are inaccurate. With DeAngelo-Masulis, the predictions vary widely; the midpoint of the predicted range is less accurate than with Miller theory. Copyright 1989 by MIT Press.

Date: 1989
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