A Switch from Debt to Equity Finance?

Abstract

The best way to reduce excessive debt leverage, and perhaps to rescue capitalism, is to remove the fiscal advantages of debt over equity finance. There should be a greater equity element in both housing and student financing, and the public sector should start issuing nominal income bonds. But the main change should occur in corporate finance. Here there are two proposals on the table, an Allowance for Corporate Equity (ACE) and Destination-based Cash Flow Taxation (DBCFT), described and discussed here. A general problem, however, is that the remuneration and incentive structure for corporate managers encourages them to maximise the return on equity (RoE), which is most easily achieved by increasing leverage. Goodhart and Lastra suggest a reformulation of limited liability for those equity holders with the power to influence corporate strategy, in order to mitigate this concern.