How Big is the Tax Advantage to Debt?

This paper uses an option valuation model of the firm to answer the question, "What magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios?" We incorporate into the model differential personal tax rates on capital gains and ordinary income. We conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms. When it is possible for the value of the underlying assets to junip discretely to zero, differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms. Moreover, if the tax advantage to debt is small, the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt-to-firm value ratios.

Debt Policy and the Rate of Return Premium to Leverage

Equilibrium in the market for real assets requires that the price of those assets be bid up to reflect the tax shields they can offer to levered firms.Thus there must be an equality between the market values of real assets and the values of optimally levered firms. The standard measure of the advantage to leverage compares the values of levered and unlevered assets, and can be misleading and difficult to interpret. We show that a meaningful measure of the advantage to debt is the extra rate of return, net of a market premium for bankruptcy risk, earned by a levered firm relative to an otherwise-identical unlevered firm. We construct an option valuation model to calculate such a measure and present extensive simulation results. We use this model to compute optimal debt maturities, show how this approach can be used for capital budgeting, and discuss its implications for the comparison of bankruptcy costs versus tax shields.

Defined Benefit versus Defined Contribution Pension Plans: What are the Real Tradeoffs?

Defined Benefit and Defined Contribution plans have significantly different characteristics with respect to the risks faced by employers and employees, the sensitivity of benefits to inflation, the flexibility of funding, and the importance of governmental supervision. In this paper, we examine some of the main tradeoffs involved in the choice between DB and DC plans. Our most general conclusion is that neither plan type can be said to wholly dominate the other from the perspective of employee welfare.The major advantage of DB plans is the potential they offer to provide a stable replacement rate of final income to workers. If the replacement rate is the relevant variable for worker retirement utility, then DB plans offer some degree of insurance against real wage risk. Of course, protection offered to workers is risk borne by the firm. As real wages change, funding rates must correspondingly adjust. However, to the extent that real wage risk is largely diversifiable to employers, and nondiversifiable to employees, the replacement rate stability should be viewed as an advantage of DB plans. The advantages of DC plans are most apparent during periods of inflation uncertainty. These are: the predictability of the value of pension wealth, the ability to invest in inflation-hedged portfolios rather than nominal DB annuities,and the fully-funded nature of the DC plan. Finally, the DC plan has the advantage that workers can more easily determine the true present value of the pension benefit they earn in any year, although they may have more incertainty about future pension-benefit flows at retirement. Measuring the present value of accruing defined benefits is difficult at best and imposes severe informational requirements on workers. Such difficulties could lead workers to misvalue their total compensation, and result in misinformed behavior.

Characterization and durability testing of plasma-sprayed zirconia-yttria and hafnia-yttria thermal barrier coatings. Part 1: Effect of spray parameters on the performance of several lots of partially stabilized zirconia-yttria powder

Initial experiments conducted on thermal barrier coatings prepared in the newly upgraded research plasma spray facility and the burner rig test facilities are discussed. Part 1 discusses experiments which establish the spray parameters for three baseline zirconia-yttria coatings. The quality of five similar coating lots was judged primarily by their response to burner rig exposure supplemented by data from other sources such as specimen characterizations and thermal diffusivity measurements. After allowing for burner rig variability, although there appears to be an optimum density (i.e., optimum microstructure) for maximum burner rig life, the distribution tends to be rather broad about the maximum. In Part 2, new hafnia-yttria-based coatings were evaluated against both baseline and alternate zirconia-yttria coatings. The hafnia-yttria coatings and the zirconia-yttria coatings that were prepared by an alternate powder vendor were very sensitive to plasma spray parameters, in that high-quality coatings were only obtained when certain parameters were employed. The reasons for this important observation are not understood. Also not understood is that the first of two replicate specimens sprayed for Part 1 consistently performed better than the second specimen. Subsequent experiments did not display this spray order affect, possibly because a chiller was installed in the torch cooling water circuit. Also, large changes in coating density were observed after switching to a new lot of electrodes. Analyses of these findings were made possible, in part, because of the development of a sensitive density measurement technique described herein in detail. The measured thermal diffusivities did not display the expected strong relationship with porosity. This surprising result was believed to have been caused by increased microcracking of the denser coatings on the stainless steel substrates

Testing for seasonal unit roots by frequency domain regression

This paper develops univariate seasonal unit root tests based on spectral regression estimators. An advantage of the frequency domain approach is that it enables serial correlation to be treated non-parametrically. We demonstrate that our proposed statistics have pivotal limiting distributions under both the null and near seasonally integrated alternatives when we allow for weak dependence in the driving shocks. This is in contrast to the popular seasonal unit root tests of, among others, Hylleberg et al. (1990) which treat serial correlation parametrically via lag augmentation of the test regression. Moreover, our analysis allows for (possibly infinite order) moving average behaviour in the shocks, while extant large sample results pertaining to the Hylleberg et al. (1990) type tests are based on the assumption of a finite autoregression. The size and power properties of our proposed frequency domain regression-based tests are explored and compared for the case of quarterly data with those of the tests of Hylleberg et al. (1990) in simulation experiments.Seasonal unit root tests; moving average; frequency domain regression; spectral density estimator; Brownian motion

Time-Varying Parameters in Continuous and Discrete Time

We consider models for both deterministic one-time and continuous stochastic parameter change in a continuous time autoregressive model around a deterministic trend function. For the latter we focus on the case where the autoregressive parameter itself follows a first-order autoregression. Exact discrete time analogue models are detailed in each case and compared to corresponding parameter change models adopted in the discrete time literature. The relationships between the parameters in the continuous time models and their discrete time analogues are also explored. For the one- time parameter change model the discrete time models used in the literature can be justified by the corresponding continuous time model, with a only a minor modification needed for the (most likely) case where the changepoint does not coincide with one of the discrete time observation points. For the stochastic parameter change model considered we show that the resulting discrete time model is characterised by an autoregressive parameter the logarithm of which follows an ARMA(1,1) process. We discuss how this relates to models which have been proposed in the discrete time stochastic unit root literature. The implications of our results for a number of extant discrete time models and testing procedures are discussed

Liquid encapsulated float zone process and apparatus

The process and apparatus for growing crystals using float zone techniques are described. A rod of crystalline materials is disposed in a cylindrical container, leaving a space between the rod and container walls. This space is filled with an encapsulant, selected to have a slightly lower melting point than the crystalline material. The rod is secured to a container end cap at one end and to a shaft at its other end. A piston slides over the rod and provides pressure to prevent loss of volatile components upon melting of the rod. Prior to melting the rod the container is first heated to melt the encapsulant, with any off-gas from this step being vented to a cavity behind the piston. The piston moves slightly forward owing to volume change upon melting of the encapsulant, and the vent passageway is closed. The container is then moved longitudinally through a heated zone to progressively melt sections of the rod as in conventional float zone processes. The float zone technique may be used in the microgravity environment of space