The public corporation as an intermediary between “Main Street” and “Wall Street”

In the perfect markets corporate finance theory (Modigliani–Miller), public corporations (firms) have no economic function. Their existence therefore cannot be justified. An unsettling implication is that the extant corporate finance theory applies to an economy in which firms are irrelevant. This research precludes this implication by identifying an economic function for firms in perfect markets. Specifically, I show that firms exist to intermediate between “Main Street” (the real sector that supplies non-financial inputs) and “Wall Street” (the financial sector that supplies cash), and that this intermediation maximizes an investment's operating cash flows by minimizing the cost of the non-financial inputs. Key implications of this rationale for the firm include: i) an investment's NPV depends on the firm's cash holdings; working capital policy is an integral part of investment policy, ii) operating characteristics determine the firm's minimum size (equity capitalization) and “boundaries,” and iii) cash on corporate balance sheets is a “fundamental” for stock-pricing.