Stew Myers

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2 Journal of Applied Corporate Finance Volume 20 Number 4 A Morgan Stanley Publication Fall 2008

The Contributions of Stewart Myers to the

Theory and Practice of Corporate Finance*

I

By exp oring t e possi i ity t at nancia structure can

ave signi cant e ects on rea corporate ecisions — ecisions

invo ving operations an capita spen ing t e wor

o Stew Myers e pe to reinstate corporate nance as ot

an important area o stu y an a critica corporate unction.

n a career of teaching and research that has nowrun more t an 2 years, an wit a stream opublications that shows no sign of diminishedvigor or insig t, MI nance pro essor Stewart

yers has had an extraordinary impact on the field of corpo-rate nance. Among is contri utions to nance t eory are

ioneering studies of capital structure, capital budgeting andva uation, an t e cost o capita or regu ate in ustries.

nd while advancing the theory of finance, Stew has alsoa a uge in uence on corporate practice. Concepts sucs “debt overhang,” the financial “pecking order,” “adjustedresent va ue,” an rea options”—a ormu ate an givenheir names by Stew—have changed how finance is appliedo practica pro ems. An generations o stu ents ave een,nd will continue to be, introduced to finance by his textbook

wit Dic Brea ey, Princip es o Corporate Finance, a oo t athanged the way finance is taught.

In t e pages t at o ow, we—t at is, two o is ormer

tudents, a colleague, and a co-author—offer a brief survey ofese accomp is ments. We egin y iscussing Stew’s worn debt overhang and corporate underinvestment, and its

ro e in setting out a researc agen a or t e e o corporatenance. Besides pointing to a key factor in current theories ofapita structure, t e concept o e t over ang as een useo shed light on issues such as the optimal design of financialontracts an t e restructuring o istresse corporate anovereign debt—critically important questions in today’snancia environment. A ter iscussing Stew’s insig ts into

hese questions, we devote the second half of the article tois wor on capita u geting, rea options, APV, an regu a-ion—all instructive examples of how theoretical ideas cane use to improve t e practice o nance.

Capital Structure (with a Look at the Optimal

Restructuring of Distressed Debt)e oun ations o t e mo ern t eory o capita structure

were laid in a classic 1958 paper by Franco Modigliani anderton Mi er ca e e Cost o Capita , Corporation

Finance, and the Theory of Investment.” There Modiglianin Mi er (or M&M,” as t ey an t eir papers came to

be called) showed that, given a set of assumptions known asper ect mar ets,” t e way a company nances itse s ou

not affect its cost of capital or market value. Differences inapita structure, or in t e in s o securities a companyssues, were shown to be nothing more than different ways oficing up t e pie o corporate operating cas ows. As ong as

he size of the pie—that is, the fundamental earnings powert e rm—was assume to e una ecte y t e nancinghanges, firm value should remain the same.

In ormu ating t is capita structure irre evance” propo-ition, M&M put an end to the debate over whether equity

was c eaper t an e t ( ecause ivi en s were ower t annterest payments) or debt was cheaper (because the cost ofa er e t was o vious y ower t an investors’ require returnn riskier equity). But what did it say to corporate practitio-ers, t e peop e entruste wit ma ing nancia ecisions?

y Franklin Allen, University of Pennsylvania, Sudipto Bhattacharya, London School of Economics,

aghuram Rajan, University of Chicago, and Antoinette Schoar, MIT

* This article was prepared for the Conference in Honor of Stew Myers that was held

September 5-6, 2008. We are grateful for the comments of conference participants, and

particularly for the many suggestions for improvement by the editor, Don Chew.


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Journal of Applied Corporate Finance • Volume 20 Number 4 A Morgan Stanley Publication Fall 2008 3

One message was that, for most companies in mostituations, t e c oice o nancing met o as at most a

“second-order” effect on firm value. And so most CEOs do notpen s eep ess nig ts t in ing a out t eir capita structure;

he asset side of the balance sheet is the main driver of value.But per aps t e most important use o t e M&M propo-

itions, for academics and practitioners alike, was to tell us w ere to oo or t e e ects o capita structure on corporatevalues. As Miller himself put it, “showing what doesn’t matteran a so s ow, y imp ication, w at oes.”1 T e M&M propo-ition effectively encouraged researchers (and CFOs) to lookore care u y at eac o t e major un er ying simp i ying

ssumptions—things like no taxes and transactions costs, ander ect in ormation—an to as questions i e t e o owing:

Could corporate or investor taxes be large enough to influ-nce a nancing c oice? Wou t e rm ace arge costs in

reworking its debt contracts in the event of financial trouble? An o outsi e investors ave enoug in ormation a out our

lans and prospects to allow us to float a new equity offering,r even cut our ivi en ?

Perhaps even more important than these assumptions,&M a so assume t at t e met o o nancing as no

ffect on corporate investment and operating decisions. But w at i it oes ? W at i companies nance main y wit

quity are more likely to take all positive-NPV projects? And w at i rms nance eavi y wit e t are etter at saying

o to value-destroying investments?Eac o t ese quest ions suggests t e possi i ity t at,

lthough capital structure is generally a second-order concern,aving t e wrong capita structure can matter a ot or mostompanies in certain situations—say, when economic uncer-ainty ma es it very cost y to re nance e t or issue equity.

Such questions also suggest that, for a small but growingu set o companies—t in a out rms contro e y privatequity or venture capital—having the right capital structurean e critica y important, an important part o t eir va ueroposition if you will.

e process o re axing t ese restrictive assumptions wasbegun by M&M themselves in a 1961 paper that pointed to

e tax s ie provi e y interest payments—a tax s ie

hat could be worth as much as 35-40 cents (depending one margina tax rate on corporate income) or every o arf debt finance. And so the theory had identified a possiblymportant ene t o issuing e t. But i t ere were no majorosts associated with debt, why not, as M&M asked, financeompanies wit 99% e t?”

In the wake of M&M, a second generation of papersn capita structure ocuse on ot er rea -wor rictions”hat, by resulting in costs as well as benefits of debt, couldui on t e groun eve e y M&M an ea to a p ausi e

heory of optimal, or value-maximizing, capital structure.mong t e most important o t ese post-M&M papers

were three by Stew Myers: (1) a 1977 paper setting out theoncept o e t over ang, w ic ecame a cornerstone o t e

“static-tradeoff” theory; (2) a 1984 paper, co-authored withic o as Maj u , t at ai t e oun ations o t e pec ing

rder” theory, which continues to be the main rival to thetatic-tra eo t eory; an Stew’s 1983 Presi entia A resso the American Finance Association, which staked out andva uate t e c aims o t ese two riva t eories.

Given Stew’s contributions to both of these theories, it isar to t in o anyone e se—apart rom M&M t emse vesnd Michael Jensen, whose work on “agency costs” we take upater— aving a compara e impact on t e stu y o corporatenance. Like Jensen’s, Stew’s work explored the possibilityat nancia structure cou ave signi cant e ects on rea

orporate decision-making—decisions involving operationsn capita spen ing. An y so oing, t ey reinstate corpo-

rate finance as both an important area of study and a criticalorporate unction.

Debt Overhang and the Corporate

Underinvestment Problem

ow et’s turn to t e t ree papers t emse ves. e speciappeal of Stew’s papers is their ability to convey insights

consi era e practica import wit remar a y simp eanguage and clear exposition. Because of the simplicity of

Stew’s mo e s, it as een easy or ot er sc o ars to see w at

akes them work, and then build upon them. And there’sno etter examp e o t is t an Stew’s 1997 paper, w ic was called “Determinants of Corporate Borrowing,” andis one o t e in isputa e c assics o t e corporate nanceiterature.

e paper egins y ui ing a mo e t at s ows w ycompany with a material probability of defaulting on itse t is i e y to cut ac on positive-NPV investments t at

require new capital, investments that are expected to increasee rm’s earnings power an so ene t a t e rm’s exist-

ng claimholders as a group (though not in equal measure, as we s a see). In Stew’s mo e , t e possi i ity o suc va ue-

reducing underinvestment arises from the combination of wo con itions: (1) t e unwi ingness o existing cre itors torovide new funding for the investment, which must thene nance y eit er existing or new equity o ers, or newnd junior debt holders; and (2) the unwillingness of exist-ng cre itors to write own or ot erwise re uce t e va ue oheir claims. Under these conditions, potential investors face aajor eterrent to provi ing un ing or t e new investment:

he prospect that much or all of the incremental payoff frome new investment project wi go to s oring up t e va ue

1. Miller (1988), p. 7.

2. Though, as Miller himself conceded in a paper also published in 1977, such tax

benefits could be largely if not completely offset by taxes paid by individual holders of

debt (as well as any tax benefits associated with equity). The current consensus on the

tax benefits of debt, to the extent one exists, puts them in an intermediate range of 10-20

cents per dollar of debt.


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4 Journal of Applied Corporate Finance • Volume 20 Number 4 A Morgan Stanley Publication • Fall 2008

f existing creditors’ claims instead of accruing to the newre itors or equity o ers.3

To illustrate this possibility with a simple example,onsi er a company t at is expecte to pro uce cas ows in

he next year of either $90 or $130, with a 50% probabilityeac , an t at, at t e en o t e year, t e rm as promise

o repay debt of $110. And let’s assume further that this firmas a new investment opportunity in its core usiness t at

requires an immediate investment of $10 and is expected tore urn at eas $10 wit in t e year. It wou c ear y e in t enterest of the firm’s stockholders to fund the investment eithery nancing it t emse ves, or issuing new e t t at is junior tots existing debt. But with the overhang of risky (and possiblyistresse ) e t in t is examp e (t at is to say, wit a 50%robability the firm won’t be able to pay back its debt of $110

in a year), neit er t e rm’s equity o ers or new investors

re likely to invest unless the incremental cash flow from thenvestments excee s $20, an not t e expecte $10. W y $20?Because under the “bad” scenario where base-case cash flowsre $90, it wou require at east $20 in incrementa ene ts

before the new junior creditors would begin to see any payoff.Given t e current expectations o a $10 incrementa gain romhe new investment, the new money earns a positive returnn y i t e goo scenario materia izes.

s this example is intended to show, companies facingmateria possi i ity o nancia istress are i e y to n itard to raise capital to fund promising new investments (orven t e asic maintenance require to preserve a given eve

f profitability), particularly under circumstances of greatuncertainty. An t is as c ear imp ications or corporateapital structure. As we will discuss in more detail later, fororporate managements oo ing or t e va ue-maximizingombination of debt and equity financing, the possibility ofuc un erinvestment is i e y to e an important reason—erhaps the most important reason—to limit debt.

More on Debt Overhang and How to Deal with It

But e ore iscussing t e imp ications o t e e t over angroblem for corporate capital structure, let’s take a closer lookt t e pro em ace y trou e companies in restructur-

ing their debt. For, as the many finance scholars who haveo owe Stew into t is area ave iscovere , t e conceptsf debt overhang and underinvestment are not only relevanto companies using or consi ering t e use o ig everage.

The concepts also raise important—and now of course highlyopica —questions o optima e t orgiveness an resc e u -ng for governments as well as corporations.

o provi e t e rea er wit a rie overview o t is itera-

ure, let’s start with the simplest possible case of renegotiatinge t in a i atera ” context in w ic a sing e e t o er is

negotiating with management and, importantly, knows asuc a out t e rm’s p ans an prospects as management. In

his admittedly artificial setting, are there ways of structuringnancing contracts or restructuring t e c aims o existingreditors that would solve the debt overhang problem andncourage new nanciers to commit capita ?

In a paper written in 1977—the same year “The Determi-ants o Borrowing” was pu is e —Su ipto B attac aryaone of the authors of this article) argued that the under-

investment pro em cou e re uce , i not e iminatentirely, by “collateralizing” the cash flows arising from the

investment un e y t e new junior cre itors—in ot er words, by guaranteeing such investors that, in the event of

uture an ruptcy, t ey an not t e o cre itors wou

ave prior right to the cash flows created by the investment.In t is situation, a t oug t ere wou sti e some trans erf value from the new investors to the existing senior debt,uc a trans er—w ic is at t e core o t e e t over angroblem—would be less than the NPV of any new invest-ent, a owing a positive NPV or t e junior cre itors an

quity holders.O course, t e ey assumption ere is t at a t e uture

ash flows from any new investment can be reliably identifiedn separate rom t e existing assets—w ic is i e y to e

very difficult if not impossible. But what if existing creditorsou e persua e to rewor t eir c aims so to ac ieve t e

ame result—namely, limiting the wealth transfer from the junior cre itors t at resu ts rom t e new investment? o

he extent we can assume that all potential parties to suchtransaction—new as we as existing cre itors an equity-olders—are equally well-informed about the company’srospects an t e expecte returns rom t e new investment,here ought to be room to strike a deal that benefits all partiesn a ows t e investment to go orwar .

But is that so? The answer provided by the model, evenun er t ese restrictive assumptions, is on y a qua i e yes.”To ensure a deal even under these circumstances requiresne more provision: t at t e e t resc e u ing (in t e orm

f a reduced claim for the existing creditors) is accomplishedsimu taneous y, an in a way t at can e veri e y t ir parties , with the junior investors’ commitment to funding the newinvestment. is is o ten ar to ring a out in practice.Credible commitments to make net new investments (in theuture) are o ten impossi e to veri y in court, as can e seen

in many ongoing disputes between privatized utilities andeir ormer regu atory aut orities. An in ot er contexts

3. More specifically, in future states of nature in which the firm’s current (without new

funding) cash flow prospects would have turned out to have been insufficient to repay its

prior debt claims, at least part of the incremental cash from the new investment would

have gone to paying off existing creditors. And in such a case, the new claimants would

not have been the full beneficiaries of the additional cash flows resulting from the new

investment they financed.

4. See Bhattacharya (1977). Another necessary condition is that the cash flows from

the new investment covary with those from the firm’s existing assets in a very weak

sense; whenever the latter is strictly higher, the former is not strictly lower.


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uch as the rescheduling of sovereign debt, which is typicallyun erta en wit t e aim o preventing un erinvestment in

ighly indebted countries, there may no judicial authority wit a man ate to en orce t e eve s o new investments t at

re (implicitly) committed to by the absolved debtor.5e ey question, t ere ore, is t is: I t e o cre itors

greed to restructure their contracts, would the equityholdersan , y extension, t e managers) n it in t eir interest to

raise the new capital to fund the investment? In a 2001 paper,B attac arya an Faure-Grimau conc u e t at, in genera ,he answer to this question is “no.” That is, there is no way

restructuring t e e t o o cre itors t at wou (1) givequity holders the incentive to make all new positive-NPVnvestments n (2) ma e t e o cre itors no worse o regar -ess of whether the new investments get made. That is the caseven i we a ow or restructurings t at invo ve more t an just

reductions in the principal of pre-existing creditors. At t e same time, an somew at surprising y, t e aut ors

lso concluded that the optimal solution in such circum-tances is to re uce t e c a ims o o cre itors (to a eve

below what would have made them indifferent whether thenew investments were carrie out) an compensate t em with equity or, better yet, warrants on the restructured firm’s

qu ty.To illustrate this point, let’s go back to our earlier example

w ere t e rm is expecte to pro uce cas ows o eit er$130 or $90, the debt repayment is $110, and the expectedains rom new investment are at east $10. In t is case, i

he firm’s senior debt claim is renegotiated down to $100,its o cre itors wou e no worse o re ative to t e statusuo of no investment. Thanks to the extra $10 or more frome investment, t e o cre itors wou e repai $100 even

under the bad scenario. And investing equity holders woulde at east as we o as un er t e status quo.

But, as the authors also show, once the senior debt claimsave een re uce , t e equity o ers wou c oose to investnly if the incremental income from the new investment ist east $15. W y? Because a ter t e o senior e t c aimas been reduced from $110 to $100, the payoff to the newquity o ers un er t e goo scenario increases rom $20 to

$30—and thus the expected value of the equity increases to$15 rom $10—even wit out any new investment requiringn outlay of $10 . If the equityholders do choose to invest, therst $10 o t e incrementa cas rom t e new investment

will end up accruing to the old creditors in the event the badcenario materia izes.

To address this underinvestment problem, the optimalrestructuring o t e senior e t—a so ution t e o cre itors

would likely accept even without the assurance that the post-restructuring investment wi e ma e—wou e to re ucehe debt claim below $100 and give the creditors warrants

wit an exercise price ig er t an $100. In t is case, w i e

he upside provided by these warrants would compensatee o cre itors or t eir arger write own, t e equity o -

rs would have greater incentive to invest because a smallerortion o t e payo s rom t e new investment wou accrueo the old creditors in the bad scenario.

Implications of Debt Overhang and Supporting Evidence. Inum, Stew’s concept o e t over ang suggests circumstances

in which both debt and equityholders could benefit—andus tota rm va ue e increase — y an agreement to write

own the face value of debt. And history has furnished at leastne supporting examp e. In t e 1930s, w en t e U.S. went

ff the gold standard and devalued the dollar with respect too , t e government ec are t at t e courts wou no ongernforce the gold indexation clauses that were contained in

virtua y a ong-term private as we as pu ic e t contracts.These gold clauses required borrowers to pay in gold if the

o ar were eva ue ; an i t e c auses a een en orce ,he debt burden of borrowers would have increased by thextent o t e eva uation, or a most 70%.

Creditors were unhappy with the government’s decisionn too t e case to t e Supreme Court. But it’s not c ear t eyuffered from the outcome of the case. In a recent workingaper tit e Is it Better to Forgive t an to Receive? An Empiri-

al Analysis of Debt Repudiation,” Randy Kroszner (formerlyt t e University o C icago, now a mem er o t e Fe era

Reserve’s Board of Governors) examined the responses oforporate e t an equity to t e Supreme Court’s ecision to

uphold this effective forgiveness of debt. Equity prices rose,s expecte , ut t e e t re ie a so e to ig er prices ororporate bonds (all of which contained gold clauses). These

responses suggest t at t e ene ts o e iminating e t over angnd avoiding bankruptcy more than offset the loss to creditors

t e sma c ance o eing repai t e a itiona 70%.Debt overhang is important not just for corporations, but

or countries. During t e Latin American e t crisis in t e

id-1980s, macroeconomists including recent Nobel laureatePau Krugman seize on it as a reason w y investment aollapsed, and why negotiating foreign debt down made sense.

W i e t eir ana ysis o t e un erinvestment pro em i eren details from Stew’s analysis,9 it was similar in spirit.

In to ay’s nancia environment, e t over ang pro emsan be seen everywhere. When beleaguered mono-line insur-rs re use to raise equity ( ecause t e procee s wou ave

5. See for example Froot et al (1989).

6. Sudipto Bhattacharya and Antoine Faure-Grimaud (2001).

7. With one possible caveat: since the old creditors would accept such a writedown

only if promised an equity- or warrant-like payoff in the good scenario, the equityholders

might be less inclined to undertake all positive NPV investments because they must be

shared with the creditors.

8. Kroszner (2003).

9. In Krugman’s version of the debt overhang and underinvestment problem faced by

sovereign governments, the country’s industrialists understand that their corporations

ill be asked to shoulder most of the higher taxes needed to pay off the debt, and they

accordingly refuse to increase their investment.


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ove lower over time instead of higher, as the static-tradeoffeory wou suggest.11

In addition to their ability to explain the financing behav-or o arge, pu ic y tra e companies, t e concepts o a verse

election and the signaling costs of raising outside equity areso o consi era e e p in un erstan ing recent events.

Commercial banks have been suffering significant losses. Butun i e t e mono- ine insurers, an s appear to ave pro uc-ive uses for additional capital, with so many assets are tradingt re-sa e prices. An unti t e recent government in usionsf equity, they seemed unable or unwilling to ra ise capitalroug pu ic issues. W at itt e capita a een raise up

o this point had come mainly from private placements witharge institutions suc as sovereign wea t un s.

The Myers-Majluf paper helps explain the difficultyraising equity un er t ese circumstances. Given t e

uncertainty about the quality of bank balance sheets, annnouncement o a arge pu ic equity issue cou ta e t e

bottom out of a bank’s stock price; it would be a signal toe mar et t at t e an is worrie a out uture osses an

wants outsiders to share the burden. It would be far better inuc cases or t e an to open its oo s to a sovereign wea tund—or to a private investor like Warren Buffett—andxp ain w y it nee s capita an w y its a ance s eet mig t

be healthier than the market believes it to be.

“Agency Costs” and Corporate Financing

In a 197 artic e ca e eory o t e Firm: Manageria

Behavior, Agency Costs, and Capital Structure,”12

Michaelensen an Wi iam Mec ing i enti e anot er potentia y

important cost associated with issuing equity to outsidenvestors. e source o suc costs was t e potentia con ict

between corporate managers and shareholders over theptima size an ris o t e rm, wit managers ten ingo place a higher value than shareholders on corporate sizen iversi cation. An t ere was a so an important con ictver corporate payout policy. As Jensen himself argued in

o ow-up artic e, corporate managers in mature in us-ries have a natural tendency to retain and reinvest excessapita —in ec ining core usinesses or iversi ying acquisi-

ions—instead of returning it to investors through dividendsr stoc uy ac s.13

One way of limiting this corporate “free cash flowro em,” as Jensen ca e it, is to pay out a arger ractionf corporate earnings as dividends. But another solution, at

east for mature companies with stable cash flows and limitedrowt opportunities, is ig everage. By orcing sucompanies to pay out (in the form of interest and principal)as ow t at cannot e pro ta y reinveste , e t nancing

as the potential to conserve value that might otherwise beost t roug negative-NPV investments. 1

The Liquidity Paradox. Thus, whereas Stew held up equitynancing as t e so ution to a e t-in uce un er nvestmentroblem, Mike Jensen saw debt as a means of curbing whatig t e escri e as a corporate investment pro em—a

roblem stemming from excess cash or liquidity.15 In Stew’sar y wor on capita structure, e assume t at corporateecisions are aimed primarily at maximizing firm value.

But in more recent wor , e o ows Jensen an Mec ingby entertaining the possibility that corporate managers have

otives ot er t an va ue maximization.

For example, in a 1998 paper called “The Paradox ofiqui ity,” Stew an Rag uram Rajan (anot er o t e co-uthors of this article) explore a different kind of corporateiqui ity” pro em, ut one t at a so as its roots in agency

osts. In this case, the conflict is not the one between manag-rs an s are o ers iscusse y Jensen an Mec ing.

Rather it’s a conflict between the managers (as representativet e s are o ers) o companies wit ots o iqui assets

nd the creditors of such companies. The problem is this:un ess t e iqui assets are p ace in a oc - ox,” manage-

ent may have no credible way of ensuring that it will notu en y trans orm” t ose assets in ways t at urt t e cre i-

ors. To illustrate the problem, think of a bank that, having just c ose a arge 10-year e t nancing a ter promising

o invest the proceeds in loans to large, investment-gradeompanies, eci es instea to ta e a ig position in su primeortgage-backed securities. As this example is meant to show,

w i e iqui ity e ps ensure t at assets can e so or ig ervalues if and when creditors get their hands on them, the

ances o cre itors actua y getting t eir an s on t em arereduced by the possibility of management’s converting themnto ess iqui an ris ier assets.

As a result of this ability to “shift liquidity” against there itors, wou - e orrowers ten to n extreme y iqui

ssets almost as hard to borrow against as highly illiquidssets. is a i ity to trans orm assets against t e interestsf creditors—literally overnight—helps explain why invest-ent an s ten to n ong-term capita so cost y, espite

he liquidity of their own balance sheets, and why so much

11. Conversely, the market leverage of firms whose earnings fall tends to increase, at

least in relation to the often depressed market value of their equity. In a 1999 paper,

Stew and Lakshmi Shyam-Sunder run a “horse race” between the static trade-off theory

and the pecking order theory, and the evidence comes out firmly in favor of the latter. See

Myers and Shyam-Sunder (1999).

12. Jensen and Meckling (1976).

13. Jensen (1986).

14. Jensen and Meckling (1976) also identified a potentially important cost associ-

ated with high leverage: the incentive it provides managers of financially distressed firms

to increase risk to take advantage of the “free option” represented by equity under those

circumstances. A similar argument was also presented by Nobel laureate Joseph Stiglitz

in a 1974 paper.

15. A number of finance scholars since then have attempted to integrate these two

counterbalancing factors—the underinvestment problem associated with too much debt

and the free cash flow problem associated with too little—into a unified theory of capital

structure. Among the most notable is a modeling framework presented in a 1995 paper

by Oliver Hart and John Moore that explores how these two offsetting factors are ex-

pected to influence the financing decisions of companies with different levels of (cash

flow) profitability and growth opportunities.


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f their financing takes the form of secured overnight loans, wit t e iqui assets poste as security. In ee , t e recent

ravails of investment banks can be attributed in significantart to t e act t at assets t at were once iqui , an t us

ormed the basis for secured borrowing, are no longer liquid.t t e same time, t e overa a ance s eets o investment

banks are still liquid enough that long-term unsecured financ-ing is extreme y expensive. us, t e investment an s areaught between a rock and a hard place.

In two sti more recent papers,1 Stew urt er exp oreshe idea of capital structure being influenced by managers’e -interest—more speci ca y, wit t e aim o maximiz-

ing the present value of their future compensation. Stew’snnovation ere is to view t e pu ic corporation as a comp extructure in which corporate managers and outside investors

ective y co- nvest to create va ue. e asic argument is

hat, in order to attract and retain the most talented andapa e top management teams, outsi e investors must e

willing to share some of the “rents,” or “private benefits,” thatome wit t e running an contro o arge pu ic compa-ies. Although such a compromise may appear to leave valueon t e ta e” or private equity rms or ot er true va ueaximizers, Stew offers the intriguing suggestion that this

ontro - an va ue-s aring arrangement, esi es eing a morerealistic account of how companies work, may end up creating

ore va ue or pu ic corporations—t ose companies t at,s one recent observer noted, “will continue to carry out theion’s s are o t e wor ’s growt opportunities.”17

One implication of this line of research, then, is toa into question t e prescription t at ong gui e corpo-

rate finance theory—that the clear duty of managers is toaximize s are o er va ue. Once we re ax t e insistence

hat shareholders are the sole residual claimants to firm value,e typica rationa es or s are o er va ue maximization—

specially the popular claim that maximizing shareholderva ue is equiva ent to maximizing rm va ue— ose t eirvalidity. Starting as early as his 1977 paper, Stew has shownn i erent ways t at s are o er va ue maximization is notlways consistent with firm value maximization. And, inis most recent paper, e as propose a promising a terna-

ive not just to the traditional concept of shareholder valueaximization, ut a so to t e goa —sti e up y mostnancial economists—of maximizing the claims of all outside rovi ers o capita . By carving in insi ers an provi ing a

return for managers’ and employees’ human capital, Steway we ave pointe to a so ution t at en s up increas-

ing the efficiency and overall earnings power of our publicompanies—t e engine t at M&M origina y i enti e ashe main source of value.

Capital Budgeting and Real Options W i e Stew’s papers on capita structure opene up a new

iterature by exploring departures from the M&M frame- wor , is contri utions to t e capita u geting iterature

ighlight a somewhat different but equally important aspectis wor . ese contri utions are examp es o is unique

bility to take an existing theory and explore its implica-ions or i erent pro ems in nance—an , in so oing,o evaluate its usefulness in organizing our thinking aboutuc pro ems. Stew’s wor in capita u ging a so re ectsis conviction that research needs to build frameworks that

re y on a t eoretica un erstan ing o t e pro ems—anunderstanding that, in this case, takes account of both capital

ar ets an corporate nancing strategy—an , as we s aee, corporate business strategy as well.

In act, one mig t say t at Stew’s wor in capita u get-

ing has helped to close a literature. Generations of students,inc u ing some o t e current aut ors, ave een taug tapital budgeting methods that rely on concepts like “value

itivity” an a juste present va ues,” o ten wit out anyreference to the original author—that is, Stew Myers. But, in

e wor s o Mic ae Jensen, t is mig t e t e est in icatorf accomplishment. Jensen once said that truly new discover-es in nance go t roug t ree stages. First peop e eny t at aew idea is correct. Then, when they recognize that the newara igm is correct, t ey o ten c aim t ey a t oug t o it

before. And when that proves wrong, people then declare theresu ts to e o vious ! A num er o Stew’s insig ts into capita

budgeting have attained this last stage of recognition, havingecome part o t e stoc o common now e ge in nance.

In the early 1970s, as we have already seen, the questionoptima capita structure a een set up y M&M as

market value maximization problem—one that, apartrom tax e ects, provi e no c ear way or i erences innancial structure to affect firm value. This meant that theost un amenta pro ems in corporate nance were t en

hought to be mainly issues of valuation, in particular theva uation o rea assets. But, or peop e i e Stew w o were working in corporate finance at this time, this represented a

a enge in t at t e met o s or va uing assets an nancia

ecurities had typically been produced by scholars working ine capita mar ets wing o nance, an so t ey o ten arriven corporate finance with a lag.

Stew’s interest in capita u geting pro ems starte with his doctoral thesis, which can be viewed as a form of

apita mar ets researc . Out o t at researc came a 19 8rticle that used a “time preference model” to demonstratee princip e o va ue a itivity”—t e i ea t at t e va ues

f individual projects within a single company can and

16. Myers (2000) and Myers and Lambrecht (forthcoming).

17. Karen Wruck, “Private Equity, Corporate Governance, and the Reinvention of the

Market for Corporate Control,” Journal of Applied Corporate Finance (Summer 2008),

Vol. 20 No. 3, p. 11.


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hould be calculated independently of one another, with nooncern a out a given project’s corre ation (or ac t ereo )

with the firm’s other assets.18 In other words, Stew showed w y companies s ou view in ivi ua projects as stan a one

apital budgeting problems rather than as parts of a corpo-rate-wi e port o io maximization pro em.19

lthough this concept of value additivity is now souc a part o our common un erstan ing t at it’s ar to

believe it has not always been this way, the idea was stronglyonteste at t e eginning o t e 1970s. Many prominent

researchers at the time followed the approach of Nobel laure-te Harry Mar owitz, w o in a 1959 artic e suggeste t atorporate capital budgeting problems be treated like an inves-or’s port o io ecision. Suc a port o io se ection approac ,remised on risk-interdependence among all investmentrojects wit in a rm, wou require corporate p anners an

nalysts to use complex portfolio selection maximizationet o s t at ta e into account t e ris c aracteristics o a

he projects or divisions within a firm when evaluating eachin ivi ua investment ecision

Stew’s work showed that, under very reasonable assump-ions, ris -in epen ence is a necessary con ition or securityarket equilibrium, thereby justifying value-maximizing

ompanies in treating t e ris c aracteristics o eac projectndependently when evaluating them. This theoretical resultas two major imp ications or CFOs an ot er nanciaecision makers: First, it greatly simplifies the tasks of finan-ia ecision ma ers since t ey can use project-speci c ur e

rates or cost-of-capital benchmarks to decide which invest-ents to pursue. Secon , it as imp ications or t e optima

orporate asset structure. Perhaps most important, it suggestsat corporate iversi cation er se oes not contri ute to

hareholder value.20

A t oug now genera y accepte y nance practitionerss well as academics, this was a novel, and counterintuitive,roposition w en Stew rst ma e it. In t e U.S. uring t e

1960s and 1970s, most practitioners appeared to believe thativersi cation strategies a t e ene cia e ect o re ucinghe cost of capital for all the investment projects within arm—an t e corporate an scape was ominate y arge

nd highly diversified conglomerates. In fact, it would takenot er eca e e ore t e insig t t at iversi cation oes notreduce the cost of capital took hold in the practice of corporate

nance. But, pro e y t e rise o private equity an ever-ged restructuring in the mid-1980s, U.S. companies startedn a pat o restructuring towar greater ocus an concentra-ion on core competencies that has continued to this day.

APV vs. NPV. In addition to its theoretical insights, Stew’s wor on capita u geting as a so pro uce a num er o

ractical approaches and tools for addressing “real-world”ro ems. One suc pro em was ow to capture t e tax

benefit of debt in the capital budgeting and valuationrocess, a question t at continues to perp ex many corpo-

rate analysts. The traditional approach was to reflect suchene ts y using t e a ter-tax cost o e t in ca cu atingcompany’s weighted average cost of capital, or WACC,

w ic in turn was use to iscount t e company’s expecteuture (pre-interest) operating cash flows. But there was onemportant imitation o t is WACC approac : it is premisen a fixed, or at least relatively stable, capital structure, anssumption t at is i e y to o on y or re ative y arge,stablished companies.

In a 197 paper, Stew provi e a way aroun t is imita-

ion by proposing an Adjusted Present Value (or APV)pproac t at ivi es t e va ue o a company (or in ivi uaroject) into two components: (1) the operating value of theompany or project (i nance entire y wit equity) an (2)he present value of the tax shield provided by debt. Thispproac as prove especia y use u or growing compa-

nies that expect to adjust their capital structure over time. A t oug it too a most a eca e or t is ogic to e u y

ccepted by practitioners, APV has become the valuationoo o c oice in everage uyouts an venture capita ea s.

But there has also been another, more general benefit ofusing APV: y separating t e e ects o nancing rom t e

real profitability of a project or company, it has provided theanagers o a in s o companies wit a way o carrying

ut one of the first principles of modern finance: the corpo-rate investment ecision comes e ore t e nancing ecision.In other words, in evaluating investments, start by lookingt t em on t eir operating merits a one; an i t ey pass t eperating test, then worry about the financing.21

A Quick Look at Real Options. One o Stew’s most impor-ant contribution to the capital budgeting literature, from aractica an conceptua stan point, may we e is more

recent work on “real options.” As noted earlier, in his 1977aper e ivi e a corporate assets into two categories:

ssets in place and growth options. He later coined the termrea options” or t e secon o t ese two categories.Real options are valuable sources of managerial flexibility

at are eit er em e e in, or can e ui t into, existingorporate assets. Examples range from mineral and drilling

rig ts e y commo ity companies to patents o p armaompanies, flexible manufacturing facilities, and expan-

18. Myers (1968).

19. As Stew himself described the intellectual lineage of this work, “Hirshleifer dis-

covered Arrow-Debreu, and I discovered Hirshleifer.”

20. This result does not deny the possibility of linkages among projects that could

lead to risk interdependence. See, for example, Myers (2001).

21. And a growing percentage of managers in large, established companies appear to

have gotten the message. In their 2001 survey of Fortune 500 CFOs, John Graham and

Campbell Harvey reported that about 10% of the CFOs claimed to use APV as their pri-

mary valuation tool while about 30% reported using WACC. And, as one might expect,

there was a strong positive correlation between use of APV method and the user ’s having

an MBA.


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ion opportunities for multinationals. As this last exampleuggests, rea options can a so e t oug t o promising invest-ent opportunities—some wholly unforeseen at the time ofe va uation—stemming rom a company’s existing capa i i-

ies and core competencies.s Stew pointe out in a c assic 198 art ic e ca e

“Finance Theory and Financial Strategy,” conventional DCFapita u geting, even w en one correct y, cannot accountor the value of real options. What is missing from simple

DCF ana ysis is t e a i ity to mo e t e exi e responsesf corporate managers and other decision makers when new

in ormation ecomes avai a e. e a i ity to structurerojects to maximize a company’s learning opportunities

w i e minimizing its up ront investment out ays is one ohe attractions of this approach.

In its narrowest range o app ications, t e rea options

pproach can be seen as an extension of financial optionricing mo e s to t e va uation o non nancia assets. Inact, Fischer Black, Myron Scholes, and Robert Mertonention t is possi i ity in t eir amous 1973 papers. e

ccomplishment of Stew’s 1984 paper was to lay out explic-t y ow to trans ate t e ogic o nancia options to a ressssues of capital budgeting and strategic planning decisions.

Stew was t e rst consistent a vocate o t is way o t in -ing; as he described himself, he was “a cheerleader for realptions.” An is a vocacy as a a major impact on t e

world of practitioners as well as academia.22

e rea options va uation approac is est suite to

ompanies whose operations involve a large componentmar et” or pu ic” ri s . C assic app icat ions o t is

ramework are investments in exploration by commodityompanies suc as oi an go pro ucers, w ere t e mainource of risk is the future price of the commodity and its

vo ati ity. In suc cases, a rea options approac encouragesnd enables analysts to make the greatest possible use of the

very etai e in ormation provi e y t e spot an uturesarkets for these commodities.

But in recent years, t e rea options approac as a sottracted interest in areas such as pharmaceutical companiesn venture capita , w ere ris s ten to e company-speci c”

r “private” (for example, the risk of a new drug’s failing toain FDA approva or ea to a commercia opportunity).In these kinds of applications, the accuracy of real optionva uations is more imite since, instea o mar et prices,nalysts must rely on subjective estimates of future cash flowsn t eir expecte varia i ity. An even in cases w ere reaptions has clear limitations as a valuation method, it cane p in t in ing a out a company’s strategic course o action.

For example, management can use the logic f real optionso ma e an initia roun o exp oratory investments wit t elear expectation that the investment will either be expandedan per aps mo i e ) i t e project turns out we , or

bandoned if things go badly. In these kinds of situations,e va uations t at are arrive at wi e on y as goo as t e

ash flow estimates that are put into the formulas. But eveno, t e rea options approac can e p management structurehe firm’s investment program in a way that achieves theost e cient reso ution o uncertainty.23

Using Finance in RegulationStew’s application of finance to corporate practice is also well

ustrate y is wor on regu ation. is wor starte witis research on how to calculate a fair rate of return for public

uti ities w i e ta ing account o in ation. His contri utions

n insurance regulation have also been very influential. Andn one area o regu ation—rate-setting rates or rai roa s—hat has had little success in recent decades, his work on the

importance o sun costs” provi es a simp e exp anationf why regulation has failed and how the problem can beorrecte .

et’s start with the case of public utilities. In a 1972 papera e e App ication o Finance eory to Pu ic Uti ity

Rate Cases,” Stew laid out a clear framework for establishingconomica y air” rates o return. In 19 9, t e Supreme

Court offered the following guidance in its ruling that

The return to the equity owner should be commensuratewit returns on investments in ot er enterprises aving corre-sponding risks. That return, moreover, should be sufficient tossure con ence in t e nancia integrity o t e enterprise, sos to maintain its credit and to attract capital. 4

In practice, state regulatory commissions have attempted topp y t is ru ing y setting consumer prices t at wou a ow

utilities to earn an adequate return on the book value of theirapita investment. An t is a so meant using istorica or

book values in calculating the cost of debt and equity, andn etermining t e weig ts to e use in coming up wit an

istorical weighted average cost of capital.Stew, owever, argue t at t e a owa e rate o returnhould be “forward-looking” and proposed a number of justments to t at en : (1) t e weig ts o e t an equity

hould be based on market values rather than book values;2) t e rate on e t s ou e ase on t e current orrow-ng costs of the firm and adjusted for taxes ; and (3) the cost

equity s ou e ca cu ate using t e eta o t e rm’s

22. An example of the latter is Stew’s work with Saman Majd on abandonment op-

tions. See Myers and Majd (1984).

23. The tremendous growth in the appeal and range of applications of real options in

the last 25 years has been attributed by many to the increasing rates of change and

volatility in markets, which reinforces the importance for managers of positioning their

firms to respond to uncertainty. For an early work that codified this body of work on real

options and linked it to the literature on investment decisions under uncertainty, see

Avinash Dixit and Robert Pindyck, Investment under Uncertainty (1994).

24. From the Supreme Court Decision on Federal Power Commission et al. v. Hope

Natural Gas Company, 320 U.S. 591 (1949) at 603.


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ssets (using firm and industry data) and the Capital AssetPricing Mo e . A t oug a t ese recommen ations aveince become standard practice, they represented a major

ange rom t e way t ings were one in t e 1950s an

19 0s.25 A secon area w ere Stew’s wor as a a signi cant

mpact is insurance regulation. His 1987 paper with RichardCo n, Insurance Rate o Return Regu ation an t e Capita Asset Pricing Model,” proposed a simple principle for deter-

ining a air rate o return to s are o ers in insuranceompanies: “Rate regulation should ensure that whenever ao icy is issue , t e resu ting equity va ue equa s t e equitynvested in support of that policy.” The implication here is

at t e premium s ou cover t e present va ues o expecteosses, the expenses incurred in administering the policies,n taxes, a ong wit a norma return on equity. By a er-

ing to this principle, insurance regulators can ensure thate va ue o s are o ers’ equity in insurance companies

is kept roughly equal to the equity investment in the firm,us provi ing t em wit an a equate rate o return an

he ability to attract new capital. Moreover, as in the caseuti ities, t e aut ors a so a vocate use o t e CAPM

o determine a fair rate of return on equity and hence theiscount rates to use in ca cu ating t ese present va ues.

This methodology works well for insurance companiesat are engage in a sing e ine o usiness. But, or insur-

nce companies with multiple lines of business, the questionis ow t e cost o equity capita s ou e a ocate to t e

ifferent lines when there is a common pool of equity avail-e to a . At t e en o t e 1990s, t e conventiona wis om

mong insurance academics was that allocation of capital byine o usiness was inappropriate or insurance companies,nd the prices of differences lines of insurance should beetermine on t e asis o t e overa ris an capita ohe insurer.26 But, in a 2001 paper, Stew and James Readointe out t at t is resu t epen s crucia y on t e a sencef frictions such as taxes and bankruptcy costs. They showedat w en taxes an an ruptcy costs are consi ere , capita

llocations can be assigned to different lines by reflectinge margina contri ution o eac to e au t va ue (w ere

hese marginal default values add up to the total expectedva ue o t e rm in t e event o e au t). is n ing as

onsiderable promise, holding out a possible basis for capitalocation among t e usiness units o not on y insurance

ompanies, but all k inds of financial firms.One area w ere regu ation appears to ave een

ineffective is the railroads. The U.S. Interstate CommerceCommission (ICC) was esta is e in 1887 to ensure t athe railroads did not use their monopoly position to exploitarmers. A ter t e Secon Wor War, t ruc ing ecamen increasingly important competitor to the railroads. By

1980 t is competition an t e requirement t at t e rai roa srovide services on even low-volume railroads had led toany an ruptcies in t e in ustry an prevente t e raising

f new capital. The Staggers Act of 1980 was designed toreverse t is tren y ta ing into account competition romhe trucking industry and making regulation less onerousn t e rai roa s. However, it as not ac ieve its aims, an

railroads in the U.S. have failed to earn their cost of capitalt any t me n recent years.

nd the U.K. has had a similar experience with itspproac to regu ation since privatizing its rai ways in 1993.

In this case, regulation has led to a drastic deteriorationt e in rastructure an t e an ruptcy o t e company

wning and operating the track.In an important 2001 paper, Stew an Jerry Hausman

rovided a convincing explanation of the failure of thisU.S. an U.K rai roa regu ation. e exp anation eginsby noting that the regulatory rate-setting process does nota e account o w at amount to signi cant sun costs”

nvolved in owning and operating railroads. Such activitiesenera y require major investments in trac s, ri ges, anunnels. And when there is a large decline in traffic, the

rate o return on rai roa s invaria y ecomes signi cant yegative. To offset this possibility, regulators must allow the

returns in perio s o eavy tra c to e muc ig er t annormal average returns in the industry—high enough toompensate or t e osses in a times. By continuing to

ignore sunk costs and limit railroad returns in good timeso norma ” eve s, U.S. an U.K. regu ators wi continueo discourage not only new investment in, but even mainte-ance o , t e existing capita stoc .

fter analyzing this regulatory problem, the paperresents a rea -options approac t at is esigne to ena e

25. In a series of papers, Stew put forward a range of arguments and evidence show-

ing why this basic methodology was the most practical and robust, and why it was su-

perior to other ways of finding of rates of return (see, for example, Myers 1972b, 1973a,

1973b, and 1978). Myers and Borucki (1994) contains a case study of a sample elec-

tric and gas utilities to investigate one of the main alternative methods for finding costs

of equity capital. This alternative methodology involves backing out the equity rate of

return for each company from the current stock price and projections of future cash flows

based on analyst estimates. For many of the companies investigated, the costs of equity

found in this way are plausible. However, there is considerable noise in the estimates and

this suggests that benchmark averages rather than single-company estimates should be

used. More importantly, the results suggest that methodologies such as those based on

the CAPM should also be used for confirmation.

The value of regulated utilities was also affected greatly by the high inflation of the

1970s and 1980s. The standard method of utility regulation involved measuring the rate

base in terms of original cost. However, in inflationary times this leads to front-end load-

ing as inflation eats away the value of the original cost. Myers, Kolbe and Tye (1985)

show how an alternative called the “trended” original cost rate base can adjust for this

problem by increasing the rate base with inflation (but with the unwanted consequence

of providing a windfall gain to current shareholders. The moderation in inflation in the

1980’s and the low inflation that was experienced in 1990’s and early to mid 2000’s

meant that this kind of change became unnecessary, but the need for it may be revived

in the coming years.

26. See Phillips, Cummins and Allen (1998), which uses the techniques developed

in Black and Cox (1976) and Merton (1977) to determine the price of insurance by line

using only line-specific liability growth rates and the overall risk of the firm.


12/13


regulators to incorporate such sunk costs when calculatingowa e rates o return.27

Brealey and Myers

The first corporate finance textbook was arguably ArthurStone Dewing’s e Financia Po icy o Corporations , w ic was first published in 1919. The book consisted mainly of

nstitutiona an ega etai s o corporations an ow t eynanced themselves. There was little if any economic or finan-ia ana ysis o w y t ese institutions or patterns a come

into being, or of the factors that would likely make themange. Over t e years, corporate nance text oo s egan to

ncorporate more economics and finance. But they remainedarge y institutiona ” in t eir ocus an met o s.

Starting with Markowitz’s development of portfolioeory, t e oun ations o t e e o nance, ot capita

arkets and corporate finance, were laid by a number ofrea t roug s an o ow-up eve opments. Besi es M&M’samous capital structure and dividend irrelevance proposi-ions note ear ier, t ere was t e S arpe-Lintner CAPM, t e

work of Fama and others on efficient markets, the Merton-B ac -Sc o es option pricing mo e , t e wor o Jensen anRoss on agency theory, and, finally, the work of Stew Myersn capita structure an capita u geting iscusse at engtbove. Although these topics had been treated in the existingext oo s, none a presente t em as a uni e w o e.

This changed with the publication, in 1981, of Brealeyn Myers’s Princip es o Corporate Finance —a oo t at,

by bringing together all the different parts of this relativelyew su ject, revo utionize t e teac ing o nance. It rapi y

became known as the “bible” of finance, a reputation thatontinues to t is ay. e g o a sa es o t e oo ave ong

been and continue to be the largest of any textbook in financet t e a vance eve . W at’s more, t e p enomena successf the book cannot be explained solely by its effectiveness

in capturing t e ey conceptua e ements o t e revo utionn finance theory. Also worth noting is a rich vein of humor

at runs t roug t e oo , a or ing moments o p easureo even the most reluctant students of this branch of theisma science.

Many generations of MBA students have learned mostt e inance t at t ey now rom Brea ey an Myers.nd the book is not likely to be displaced or supersededy a competitor any time soon—i on y ecause t e timenvolved in writing a textbook from scratch means that thiss no onger an economic proposition or nance aca emics.

By 2058 “gargle blasters” will be a reality. And when the5t e ition o Brea ey an Myers is pu is e in t at year, it

will be co-authored by Aggarwal and Chen, while Shanghai

nd Mumbai will have overtaken London and New York asnancia centers. But stu ents aroun t e wor wi continueo get their introduction to finance from the “bible.”

franklin allen is the Nippon Life Professor of Finance and Profes-

sor of Economics at the University of Pennsylvania’s Wharton School of

Business.

sudipto bhattacharya is Professor of Finance at the London

School of Economics.

raghuram rajan is Eric J. Gleacher Distinguished Service Professor

of Finance at the University of Chicago’s Graduate School of Business.

antoinette schoar is Michael M. Koerner Associate Professor of

Entrepreneurial Finance at the MIT Sloan School of Management.

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S. C. Myers, 1973 , On Pu ic Uti ity Regu ation un er

ncertainty.” Risk and Regulated Firms, Ed: R.H. Howard,ansing, MI: Mic igan State University Pu ic Uti itiesPapers.

S. C. Myers, 197 , Interactions o Corporate Financingnd Investment Decisions -- Implications for Capital Budget-ng,” Journa o Finance , Vo . 29(1), pp. 1-25.

S. C. Myers, 1977, “Determinants of Corporate Borrow-ng”, Journa o Financia Economics, Vo . 5(2), pp. 1 7-175.

S. C. Myers, 1978, “On the Use of Modern PortfolioT eory in Pu ic Uti ity Rate Cases: A Comment,” Financia Management , Vol. 7(3), pp. 66-68.

S. C. Myers, 198 , e Capita Structure Puzz e,”

Journal of Finance, Vol. 39(3), pp. 575-592.

S.C. Myers, “Finance Theory and Financial Strategy,”Inter aces, January/Fe ruary, 198 . pp. 12 -137.

S. C. Myers, 2000, “Outside Equity,” Journal of Finance ,Vo . 55(3), pp. 1005-1037.

S.C. Myers, 2001, “Capital Structure,” Journal ofconom c erspect ves , Vo . 15(2), pp. 81-102.

S. C. Myers and N. Majluf, 1984, “Corporate Financ-ng an Investment Decisions w en Firms Have In ormation

That Investors Do Not Have,” Journal of Financial Economics,Vo . 13(2), pp. 187-221.

S.C. Myers and Saman Majd (1984), “Calculating the A an onment Va ue Using

Options Pricing Theory”, MIT Sloan School ofanagement Wor ing paper, No. 93-

001WP, November S.C. Myers and R. Cohn, 1987,Insurance Rate o Return Regu ation an t e Capita Asset

Pricing Model.” Fair Rate of Return in Property Liabilitynsurance, E s: J.D. Cummins an S. Harrington, Norwe , A: Kluwer-Nijhoff Publishing Co.

S. C. Myers an L.S. Boruc i, 199 , Discounte CasFlow Estimates of the Cost of Equity Capital,” inancial Mar ets, Institutions an Investments , Vo . 3(3), pp. 9- 5.

S.C Myers, A.L. Kolbe, and W.B. Tye, 1984,”Regulationn Capita Formation in t e Oi Pipe ine In ustry,” rans-ortation Journal , Vol. 23(4), pp. 25-49.

S.C. Myers, A.L. Ko e, an W.B. ye, 1985,”In ationnd Rate of Return Regulation” Research in Transportationconom cs Vo . 2, pp. 103-119.

S.C. Myers, A. L. Kolbe, and W.B. Tye, 1993, RegulatoryRis : Economic Princip es an App ications to Natura GasPipelines and Other Industries, Boston: Kluwer AcademicPu is ers.

S. C. Myers and R. Rajan, 1998,“The Paradox ofiqui ity,” Quarter y Journa o Economics , Vo . 113(3), pp.33-771.

S. C. Myers an J.A. Rea , Jr., 2001, Capita A ocationor Insurance Companies,” Journal of Risk and Insurance Vol.8( ), pp. 5 5-580.

R.D. Philips, J.D. Cummins, and F. Allen,1998, “Finan-ia Pricing o Insurance in t e Mu tip e Line Insurance

Company, ournal of Risk and Insurance , Vol. 65(4), pp.597- 3 .. Shyam-Sundar and S.C. Myers, 1999, “Testing Static

ra e-o against Pec ing Or er Mo e s o Capita Struc-ure,” Journal of Financial Economics , Vol. 51(2), pp. 219-244.vai a e at SSRN: t tp : papers.ssrn.com so 3 papers.fm?abstract_id=226998.

Stig itz, J.E., 197 , In ormation an Capita Mar ets.”Financial Economics: Essays in Honor of Paul Cootner,

: C.M. Cootner an WF. S arpe., New Jersey: Prentice-Hall.

Stew Myers

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