The Modigliani-Miller Theorem with Financial Intermediation

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DOI: 10.4236/me.2011.22022    6,401 Downloads   11,731 Views   Citations

ABSTRACT

This paper shows that, if firms borrow at an interest rate that is greater than the rate at which they can lend, the value of a firm declines with the amount borrowed. The model assumes the possibility that a firm may go bankrupt, which introduces the need for financial intermediation. A modified version of the homemade lev-erage examples introduced by Modigliani and Miller [2] is used to introduce the concept. A state-preference model is used for a more formal proof.

Cite this paper

J. McDonald, "The Modigliani-Miller Theorem with Financial Intermediation," Modern Economy, Vol. 2 No. 2, 2011, pp. 169-173. doi: 10.4236/me.2011.22022.

Conflicts of Interest

The authors declare no conflicts of interest.

References

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[2] F. Modigliani and M. Miller, “The Cost of Capital, Corporation Finance, and the Theory of Investment,” The American Economic Review, Vol. 48, No. 3, June 1958, pp. 261-297.
[3] K. Arrow, B. Bernheim, M. Feldstein, D. McFadden, J. Poterba and R. Solow, “100 Years of the American Economic Review: The Top 20 Articles,” American Economic Review, Vol. 101, No. 1, 2011, pp. 1-8. doi:10.1257/aer.101.1.1
[4] M. Woodford, “Financial Intermediation and Macroeconomic Analysis,” Journal of Economic Perspectives, Vol. 24, No. 4, 2010, 21-44. doi:10.1257/jep.24.4.21
[5] M. Goodfriend and B. McCallum, “Banking and Interest Rates in Monetary Policy Analysis: A Quantitative Exploration,” Journal of Monetary Economics, Vol. 54, No. 5, July 2007, pp. 1480-1507. doi:10.1016/j.jmoneco.2007.06.009
[6] J. Stiglitz, “A Re-examination of the Modigliani-Miller Theorem,” The American Economic Review, Vol. 59, No. 5, December 1969, pp. 784-793.
[7] T. Sargent, “Macroeconomic Theory,” 2nd Edition, Academic Press, Orlando, 1987.

  
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