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

Jianying Qiu and Prashanth Mahagaonkar
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Prashanth Mahagaonkar: Max Planck Institute of Economics, EGP Group, Kahlaische Str. 10, D-07745 Jena, Germany // Schumpeter School of Business and Economics, University of Wuppertal, Germany

No sdp09006, Schumpeter Discussion Papers from Universitätsbibliothek Wuppertal, University Library

Abstract: In this paper, we directly test the Modigliani-Miller theorem in the lab. Applying a general equilibrium approach and not allowing for arbitrage among firms with different capital structures, we are able to address this issue without making any assumptions about individuals' risk attitudes and initial wealth positions. We find that, consistent with the Modigliani-Miller theorem, experimental subjects well recognized the increased systematic risk of equity with increasing leverage and accordingly demanded higher rate of return. Furthermore, the correlation between the value of the debt and equity is -0.94, which is surprisingly comparable with the -1 predicted by the Modigliani-Miller theorem. Yet, a U shape cost of capital seems to organize the data better.

Keywords: The Modigliani-Miller Theorem; Experimental Study; Decision Making under Uncertainty; General Equilibrium (search for similar items in EconPapers)
JEL-codes: C91 D53 G12 G32 (search for similar items in EconPapers)
Pages: 27
Date: 2009-06
New Economics Papers: this item is included in nep-cfn, nep-exp and nep-hpe
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Related works:
Working Paper: Testing the Modigliani-Miller theorem directly in the lab: a general equilibrium approach (2009)
Working Paper: Testing the Modigliani-Miller theorem directly in the lab: a general equilibrium approach (2008)
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