The Modigliani-Miller Theorem for Equity Participation


The paper shows that the use of an equity participation loan has no effect on the value of the firm, and that taxation of the borrowing firm and lender reduces firm value. The paper includes the assumption that firms borrow at an interest rate that is greater than the rate at which they can lend, so the value of the firm declines with the amount borrowed. Also, it is assumed that the firm may go bankrupt, which introduces the need for financial intermediation, as discussed by McDonald [1]. A state-preference model is employed.

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J. F. McDonald, "The Modigliani-Miller Theorem for Equity Participation," Theoretical Economics Letters, Vol. 2 No. 4, 2012, pp. 361-364. doi: 10.4236/tel.2012.24066.

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The authors declare no conflicts of interest.


[1] J. McDonald, “The Modigliani-Miller Theorem with Financial Intermediation,” Modern Economy, Vol. 2, No. 2, 2011, pp. 169-173.
[2] F. Modigliani and M. Miller, “The Cost of Capital, Corporation Finance, and the Theory of Investment,” American Economic Review, Vol. 48, No. 3, 1958, pp. 261-297.
[3] J. Stiglitz, “A Re-Examination of the Modigliani-Miller Theorem,” American Economic Review, Vol. 59, No. 5, 1969, pp. 784-793.
[4] J. A. Schnabel, “An Agency-theoretic Perspective on Participation Clauses in Loan Contracts,” Journal of Business Finance and Accounting, Vol. 20, No. 1, 1993, pp. 133-142. Hdoi:10.1111/j.1468-5957.1993.tb00256.x
[5] M. S. Ebrahim, “On the Design and Pareto-Optimality of Participating Mortgages,” Real Estate Economics, Vol. 24, No. 3, 1996, pp. 407-419. Hdoi:10.1111/1540-6229.00697
[6] J. R. Alvayay, C. Harter and W. S. Smith, “A Theoretic Analysis of Extent of Lender Participation in a Participating Mortgage,” Review of Quantitative Finance and Accounting, Vol. 25, No. 4, 2005, pp. 383-411. Hdoi:10.1007/s11156-005-5461-z
[7] M. S. Ebrahim, M. Shackleton and R. Wojakowski, “Valuing Participating Mortgage Loans Using Profit Caps and Floors,” Discussion Paper, Lancaster University Management School, Lancaster, 2008.
[8] T. Sargent, “Macroeconomic Theory,” 2nd Edition, Academic Press, Orlando, 1987.

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