Inflationary Expectations and the Market Value of the Firm.

This dissertation examines one effect of inflation on the value of the firm— the Keynes-Fisher Hypothesis that debtor firms benefit from unanticipated inflation. The primary objective of this study is to determine what, if any, differences in performance exist as a result of net monetary debtor or creditor status during different inflationary conditions. The literature on debtor versus creditor performance during inflation reflects a lack of agreement on the validity of the Keynes-Fisher Hypothesis. The findings of previous tests of debtor versus creditor performance are not homogeneous, and conflicts exist between such studies and the theoretical effects of unanticipated inflation. This dissertation suggests the lack of consensus is the result of improper tests and consideration of only the short run effects of anticipated inflation on holding period returns. Initially, rank correlation tests were applied to a sample of Compustat firms to test for a relationship between net monetary debtorcreditor status and holding period returns. These tests indicated the inability of rank correlation methods to detect debtor benefits even in periods of unanticipated inflation. The differences between several of the prior studies are likely due to the use of this technique. It Is necessary first to control for several other factors in order to detect those effects which result from debtor-creditor status. vii A series of tests to isolate the effect of debtor-creditor status on holding period yields were conducted by constructing separate portfolios of debtor and of creditor firms, identical in all Important respects except net monetary debtor-creditor status. In this way, any statistically significant differences in holding period yields could be attributed to differences in debtor-creditor status. The findings generally were consistent with the hypothesis of this dissertation and with research identifying periods of unanticipated inflation. Specifically in periods with relatively high unanticipated inflation (1955-59 and after 1967), debtor firms demonstrated superior holding period returns. In the interim period of more correctly anticipated inflation, no difference in the performance of debtor versus creditor portfolios was detected. However, two findings were not as expected. Creditor benefits appear in two periods. The five-year lagged holding period yields for creditor portfolios was superior to debtors in the 1969-73 and 1970-74 periods, even though inflation was not found to be overanticipated in either of the preceding five-year periods. Second, debtor benefits do not reappear strongly after 1967 when the degree of unanticipated inflation was as great as before 1960. Two trends were noted and examined as possible explanations of these unexpected findings. First, it was noted that the variance in expected inflation for a given period had been increasing in the late 1960's. Increased uncertainty surrounding inflation forecasts would have the same effect as higher inflationary expectations, thereby decreasing debtor benefits and perhaps even causing creditor benefits in some periods. Second, the superior stock performance of net monetary viii debtors was observed only several years subsequent to periods of unanticipated inflation. As would be expected in a rational market, the superior performance of debtor firms was followed by an increase in the percentage of debtor firms. The increase was concurrent with the observed lag structure in performance. This dissertation has provided comprehensive explanations of the inconsistencies of prior studies as well as empirical evidence supporting these explanations. It develops an hypothesis supported by empirical tests which reconciles the findings of previous studies with research measuring the degree of unanticipated inflation. Finally, the likely implication of recent trends is examined along with promising areas for further research.