Taxation, Portfolio Choice, and Debt-Equity Ratios: A General Equilibrium Model

34 Pages Posted: 4 Jul 2004 Last revised: 1 Jul 2010

See all articles by Alan J. Auerbach

Alan J. Auerbach

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Mervyn King

Bank of England; National Bureau of Economic Research (NBER)

Date Written: August 1980

Abstract

This paper explores the portfolio behavior of investors differing with respect to both tax rates and risk-aversion, emphasizing the role of constraints on individual and firm behavior in ensuring the existence of and characterizing portfolio equilibrium. Under certain conditions on the securities available in the market, which also are required for shareholders to be unanimous in supporting firm value maximization, investors will be segmented by tax rate into two groups, one specialized in equity and the other in debt. Though the relative wealths of the two groups determines the aggregate debt-equity ratio, each firm will be indifferent to its financial policy.

Suggested Citation

Auerbach, Alan Jeffrey and King, Mervyn A., Taxation, Portfolio Choice, and Debt-Equity Ratios: A General Equilibrium Model (August 1980). NBER Working Paper No. w0546. Available at SSRN: https://ssrn.com/abstract=227525

Alan Jeffrey Auerbach (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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Mervyn A. King

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