 Testing the Modigliani-Miller Theorem of Capital Structure Irrelevance for BanksNo WP15-8, Working Paper Series from Peterson Institute for International Economics Abstract: Some advocates of far higher capital requirements for banks invoke the Modigliani-Miller theorem as grounds for judging that associated costs would be minimal. The M&M theorem holds that the average cost of capital to the firm is independent of capital structure, because any reduction in capital cost from switching to higher leverage using lower-cost debt is exactly offset by an induced increase in the unit cost of higher-cost equity capital as a consequence of the associated rise in risk. Statistical tests for large US banks in 2002–13 find that less than half of this M&M offset attains in practice. Higher capital requirements would thus impose increases in lending costs, with associated output costs from lower capital formation. These costs to the economy would need to be compared with benefits from lower risk of banking crises to arrive at optimal levels of capital requirements. Keywords: Financial Regulation; Bank Capital Requirements; Capital Structure (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:iie:wpaper:wp15-8 Access Statistics for this paper More papers in Working Paper Series from Peterson Institute for International Economics Contact information at EDIRC. |
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