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Testing the Modigliani-Miller theorem directly in the lab

Maria Levati, Jianying Qiu and Prashanth Mahagaonkar
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Prashanth Mahagaonkar: Max Planck Institute of Economics, Jena - Entrepreneurship, Growth and Public Policy Group

No 2011-021, Jena Economics Research Papers from Friedrich-Schiller-University Jena

Abstract: We present an experiment designed to test the Modigliani-Miller theorem. Applying a general equilibrium approach and not allowing for arbitrage among firms with different capital structures, we find that, in accordance with the theorem, participants well recognize changes in the systematic risk of equity associated with increasing leverage and, accordingly, demand higher rate of return. Yet, this adjustment is not perfect: subjects underestimate the systematic risk of low-leveraged equity whereas they overestimate the systematic risk of high-leveraged equity, resulting in a U-shaped cost of capital. A (control) individual decision-making experiment, eliciting several points on individual demand and supply curves for shares, provides some support for the theore

Keywords: Modigliani-Miller theorem; Experiments; Decision making under risk; General equilibrium (search for similar items in EconPapers)
JEL-codes: C91 D53 G12 G32 (search for similar items in EconPapers)
Date: 2011-04-18
New Economics Papers: this item is included in nep-cfn and nep-exp
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Journal Article: Testing the Modigliani-Miller theorem directly in the lab (2012) Downloads
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