The nominal contracting hypothesis argues that changes in subsequent inflation expectations cause a change in the market value of fixed-rate debt instruments, especially long-term debt, which, in turn, should be capitalized into the market price of equity. Little, if any, supporting evidence has been found for the theoretically anticipated wealth redistribution effects of inflation from bondholders (creditors) to shareholders (debtors). Using micro-firm data for the period 1961-1985, evidence is provided in support of the hypothesis. The data consist of 50 semiannual cross-sectional samples of nonfinancial and nonutility corporations drawn from the COMPUSTAT and CRISP files. Model specification is improved by: 1. recognizing explicitly that a firm's asset and capital structure variables are balance-sheet constrained, and 2. controlling for individual firm risk differences and capital gains taxation.
Full text: The Review of Economics and Statistics, May 1989
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