Government as the Firm's Third Financial Stakeholder: Impact on Capital Structure Discount Rates and Valuation

43 Pages Posted: 2 Apr 2009 Last revised: 6 Dec 2010

See all articles by Ronald W. Spahr

Ronald W. Spahr

University of Memphis - Finance

Pankaj K. Jain

University of Memphis - Fogelman College of Business and Economics

Fariz Huseynov

North Dakota State University - College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: November 28, 2010

Abstract

We extend Myers’ Adjusted Present Value method (Myers, 1974) and modify Modigliani and Miller’s capital structure propositions (MM 1958, 1963) by adding government as the third major financial stakeholder. Stockholders, bondholders and government (federal and state) each possess a stake in the firm because of the potential to receive future cash flows. Given M&M’s no growth assumption, we posit a “conservation of value” where a firm’s capital structure and tax structure have no effect on total firm value; however, have major effects on relative stakeholder values and appropriate discount rates. Considering the three stakeholder model helps clarify the controversy over appropriate discount rates for each stakeholder’s cash flows, the social discount rate and tax structure. We further extend our models in an intertemporal framework that allows for reinvestment of earnings and firm growth. This extension provides clarification and has significant implications regarding firm valuation, capital investment and capital structure policy. We demonstrate that the corporate tax burden ultimately falls on shareowners and government is the beneficiary, whether the tax incidence is at corporate or individual level. However, corporate taxes may significantly impact domestic corporations’ abilities to compete in a global economy. In an intertemporal framework, shifting the tax burden from corporations to individuals and lowering the overall tax rates may increase government’s tax revenues through corporate growth despite a reduced proportional stake in firms.

Keywords: Tax, capital structure, government, stakeholder, growth

JEL Classification: E62, H2, H21, K34

Suggested Citation

Spahr, Ronald W. and Jain, Pankaj K. and Huseynov, Fariz, Government as the Firm's Third Financial Stakeholder: Impact on Capital Structure Discount Rates and Valuation (November 28, 2010). Available at SSRN: https://ssrn.com/abstract=1365021 or http://dx.doi.org/10.2139/ssrn.1365021

Ronald W. Spahr

University of Memphis - Finance ( email )

United States

Pankaj K. Jain

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States

Fariz Huseynov (Contact Author)

North Dakota State University - College of Business ( email )

Department of Acctg, Finance & Information Systems
Fargo, ND 58108
United States
+17012315074 (Phone)

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