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Title:Testing the Modigliani-Miller theorem directly in the lab: a general equilibrium approach PDF Logo
Authors:Mahagaonkar, Prashanth
Qiu, Jianying
Issue Date:2008
Series/Report no.:Jena economic research papers 2008,056
Abstract: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
Subjects:The Modigliani-Miller Theorem
experimental study
decision making under uncertainty
general equilibrium
JEL:G32
C91
G12
D53
Document Type:Working Paper
Appears in Collections:Jena Economic Research Papers, MPI für Ökonomik

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