The Behavior of Financial Structure and Sustainable Growth in an Inflationary Environment

Johnson, Dana J.
September 1981
Financial Management (1972);Autumn81, Vol. 10 Issue 4, p30
Academic Journal
The article investigates the effects of inflation on the financial structure and sustainable growth of a business. In 1977 R. C. Higgins demonstrated that the financial policies of many corporate managers may be inconsistent with their growth objectives. Because of depressed equity markets, constant debt-to-equity and dividend payout ratios may be impossible to maintain in achieving high rates of corporate growth. As a guide for setting compatible financial policies and growth objectives, Higgins derived a formula for a rate of sustainable growth. In deriving the sustainable growth rate under inflation, Higgins makes several assumptions, such as depreciation is just sufficient to maintain the value of existing assets and the firm relies only on retained earnings each year for equity financing. Assuming the firm adheres to a target capital structure rather than financial structure, the effects of inflation on the real rate of sustainable growth are not necessarily adverse. Furthermore, avoiding such adverse effects does not depend on the use of either an aggressive or a conservative financing strategy, but rather is a function of the relationship between the nominal increases in the firm's assets and liabilities. In contrast, the firm's total debt-to-equity ratio unavoidably increases with the rate of inflation.


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