EFFECTS OF OWNERSHIP PATTERN ON CAPITAL STRUCTURE: A SPECIAL CASE OF STOCK AND MUTUAL PROPERTY LIABILITY INSURANCE FIRMS (SOLVENCY, LIQUIDITY)

Traditional finance theory assumes separation of the financing and operating decisions in a firm. Any decision to issue more policies by an insurance firm is an operating decision. It also changes the liability side of the balance sheet. Thus this is also a financing decision.;Models for both stock and mutual property liability insurance firms are built.;First, the situation in an idealized world without taxes is discussed. It is shown that in the absence of monitoring, both stock and mutual firms will minimize equity. When monitoring is allowed, firms may minimize or maximize equity depending on the circumstances. Under certain other conditions firms may be indifferent to the level of equity.;Next, taxes are introduced into the scenario. Under these conditions both stock and mutual firms may have optimal levels of equity which could be zero or infinite. Conditions when the optimal level of equity is non-zero and finite are also discussed.;The way a firm behaves depends on its ownership form, i.e., whether stock or mutual. It is argued that stock insurance firms are stockholders' wealth maximizers. Mutual insurance firms try to maximize the ex ante value of the policyholders' wealth.;The predictions of the models are then compared with data for actual insurance firms. It is found that the models' predictions bear resemblance to reality.