Testing the Modigliani-Miller theorem directly in the lab: a general equilibrium approach

Arbeitspapier

In this paper, we experimentally test the Modigliani-Miller theorem. Applying a general equilibrium approach and not allowing for arbitrage among firms with different capital structure, we are able to address a question fundamental to the valuation of firms: does capital structure affect the value of the firm? If so, how? We find that, consistent with the Modigliani-Miller theorem, experimental subjects well recognized the increased systematic risk of the equity with increasing leverage and accordingly demanded higher rate of return. Yet, this adjustment was not perfect: subjects underestimated the systematic risk of low leveraged equity whereas overestimated the systematic risk of high leveraged equity, resulting in a U shape weighted average cost of capital

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Jena Economic Research Papers ; No. 2008,056

Classification and Topics

• Classification: Wirtschaft ; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill ; Design of Experiments: Laboratory, Individual ; Asset Pricing; Trading Volume; Bond Interest Rates ; General Equilibrium and Disequilibrium: Financial Markets
• Subject: The Modigliani-Miller Theorem ; experimental study ; decision making under uncertainty ; general equilibrium ; Kapitalstruktur ; Entscheidung bei Unsicherheit ; Allgemeines Gleichgewicht ; Test ; Kapitalkosten ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Mahagaonkar, Prashanth ; Qiu, Jianying
• Event: Veröffentlichung
• (who): Friedrich Schiller University Jena and Max Planck Institute of Economics
• (where): Jena
• (when): 2008

Further information

• Handle: http://hdl.handle.net/10419/25738
• Last update: 10.03.2025, 11:44 AM CET