An empirical analysis of the effects of price-level changes upon selected firms' earned capital
The objectives of the study are: (1) to determine whether or not price-level changes will have an effect upon the selected firms' earned capital, (2) to determine if the Pffect of inflation on the earned capital of the public utility companies is less than equal to or more than the effect on the earned capital of other industries, and (3) to identify critical variables affecting the selected firms' earned capital erosion due to price-level changes.Subjects were 153 companies: 38 non-utility companies and 115 utility companies. Equal size observations were used in analyzing each group (approximately 380, or 190 each).To obtain data the study chose firms from COMPUSTAT tapes for the years 1977 through 1981. Although several adjusted information items were available, some adjustments were needed for analysis, such as depreciation and tax liabilities. Price-level adjustments were made in accordance with procedures recommended by the Financial Accounting Standards Board.For the statistical analysis, the following null hypotheses were tested at the .05 level of significance:Ho1 : The price-level change will not affect the firms' earned capital erosion.H02 : (1) There is no significant earned capital erosion of the non-utility industry due to price-level changes (lefttailed test).(2) There is significant earned capital erosion of the utility industry due to price-level changes (righttailed test).The Z test statistic was used to test each null hypothesis. Multiple regression analyses were done to identify the critical variables affecting the firms' earned capital erosion under the price-level changes by using taxation, depreciation, payout ratio, and rate of inflation variables.As a result of the hypotheses, null hypothesis 1 was rejected. It could be concluded that the price-level changes did affect the firms' earned capital erosion due to inflation.Null hypothesis 2 for the non-utility industry was rejected (p<.05). The analysis indicated that there is significant earned capital erosion of the non-utility industry due to price-level changes. The null hypothesis 2 for the utility industry was rejected also. It could be concluded that there was no significant earned capital erosion of the utility industry due to inflation.From these results the first and second objectives of the research were met. The price-level changes did affect the selected firms' earned capital, the direction of the earned capital erosion between non-utility and utility groups was completely opposite. The price-level changes do erode the firms' earned capital, but this is not the case for the utility industry. The results of regression analysis indicated that the critical variables affecting the firms' earned capital erosion were taxation, depreciation, payout ratio, and rate of inflation. However, the relative importance of the independent variables was slightly different between the two groups.For the non-utility group the most important variable was payout ratio, followed by taxation and rate of inflation. In the utility industry group the most important variable was taxation, followed by depreciation, rate of inflation, and payout ratio.The following recommendations are made for further research:1. This study should be linked with the analysis of general capital erosion including contributedcapital under the price-level changes.2. The inventory valuation method should be considered for the future analysis of capitalerosion by using dummy variables, although these were not used in this research. It willcertainly become a more powerful model if the inventory valuation method were considered.3. For the in-depth analysis different models should be used for the different industry groups,and not just a general model.4. A study on the microeconomic effects of the tax burden shift associated with capital erosion due to inflation behavior is recommended.5. Finally, any kind of action to be taken by the Congress should be designed to alleviate capital erosion due to inflation.It is strongly recommended that the utility industry not include monetary gains or losses in the calculation of taxable income to prevent corporations' capital from overpaying through income taxing.