Limited Liability Effect, Z Cost, And The Corporate Debt Financing Policy

Based on a systematical analysis on the classical capital structure theory and its recent advances, this paper proposes and proves that the corporate debt financing policy has rigidity tendency for the limited liability effect of corporate borrowing, and there exist the so-called value effect and the general equilibrium effect of corporate tax affecting the corporate borrowing decisions. In addition, the notion of Z cost is introduced and the relationships between Z costs and corporate borrowing decisions are investigated in this paper. This paper proposes the notion of the rigidity of corporate borrowing, and suggests, all else being constant, the financial managers tend to increase borrowing and do not want to increase equity capital. For the limited liability of corporate borrowing, the equity-holders can benefit from the moderate further borrowing if the interest rate of the original debt is given. For a similar reason, other things being equal, the equity-holders will lose from the further increasing in equity capital. Furthermore, this paper also illustrates this from a viewpoint of option. In fact, in the firm's financing practice, the so-called distorted behaviors of financial managers, and the fact that the oligopoly tends to increase debt financing to get an advantage in its products strategy in the oligopoly product markets are both specific demonstrations of the principle of the rigidity of corporate borrowing. According to the income effect and the substitution effect of price change in microeconomics analysis, this paper suggests that there exists the so-called value effect of corporate tax affecting corporate debt financing policy, and discusses the special case of the so-called "Giffen"abnormity of debt financing, which may explain the abnormality to some degree that why some firms tend to use debt conservatively when the financial distress and potential bankruptcy costs are not significant enough to counteract the tax shield value of debt financing, and also discusses how changes in corporate tax rate affect the firm's debt financing decision from a general equilibrium view. Finally, in a similar way as the agency cost, this paper suggests, even in a system where no agency problems exist, the owner, acting as the manager, does not necessarily work hard for his/her firm as possible, and thus exist the so-called Z costs, which are viewed to be the inefficiency costs of the manager when there exist no agency problems, or the costs associated with the inefficiency costs in a system where the agency problem does not matter, and distinguishes the objective Z costs from the subjective Z costs according to the reasons of the manager, or the owner's behaviors leading to the inefficiency costs. In terms of the relationships between the agency costs and firm's financing policy, this paper also investigates the relationships between the Z costs and firm's financing policy.