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SHAREHOLDER LIMITED LIABILITY AND MEAN‐VARIANCE MODELS OF CAPITAL STRUCTURE *
Author(s) -
Rhee S. Ghon
Publication year - 1984
Publication title -
decision sciences
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.238
H-Index - 108
eISSN - 1540-5915
pISSN - 0011-7315
DOI - 10.1111/j.1540-5915.1984.tb01192.x
Subject(s) - bankruptcy , limited liability , capital structure , liability , debt , economics , variance (accounting) , shareholder , actuarial science , business , monetary economics , microeconomics , financial economics , finance , accounting , corporate governance
This paper demonstrates that shareholder limited liability imposes a restriction on corporate borrowing and that failure to incorporate this restriction into the analysis yields the “reductio ad absurdum” argument against mean‐variance models of optimal capital structure. With corporate income taxes and costless bankruptcy, the firm's value is a monotonically increasing function of debt as long as the amount of debt does not exceed the upper limit imposed by shareholder limited liability. As a result, the introduction of costly bankruptcy into the mean‐variance framework is justified.