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Essay / Research Paper Abstract
This 9 page report includes three separate discussions of: capital structure theory, especially as presented in the theories of Modigliani and Miller; the principal agent theory and an examination of the shareholder wealth maximization hypothesis; and, dividend policy theory, especially as related to Modligani and Miller’s theory of the irrelevance of capital structure.
Bibliography lists 6 sources.
Page Count:
9 pages (~225 words per page)
File: D0_BWcpd.rtf
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Unformatted sample text from the term paper:
an illustration of how corporate value stems from its assets earning power and the level of risk of its business line rather than from its capital structure. Along with much
of their other independent work they, according to Bernstein (1990), fundamentally "transformed the entire world of finance" (pp. 81). The central component in
the theorems of Miller and Modigliani (also known as "M&M") is that the earning ability or power of any corporations assets and the riskiness of its line of business essentially
define the value of the corporation. The paper the corporation issues -- promissory notes, bonds, and stocks -- is nothing more than claims against the assets. When one combines all
the pieces of paper, and, regardless of the market value of the separate elements individually, the resulting sum must match the value of the assets.
The chief financial officers of the corporation can reorganize those paper claims, but rearranging the claims does not change the earning power of the plant, equipment, inventory,
patents and other franchises -- or the overall riskiness of the enterprise -- that ultimately determine corporate profitability and value. a companys value is independent of its capital structure -
no matter how you slice it. As a result, there really is no "optimal" capital structure. In effect, M&M promotes a concept that warns a corporation against attempt to make
its shareholders wealthy by adjusting debt levels, because - at least in the somewhat idealized world in which economists operate, and sometimes in practice - it wont work. Instead, M&M
argues, the companys best capital structure is one that supports the operations and investments of the business. Earning power, not finance, determines the cost of capital.
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