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

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Author Info
Jianying Qiu (Department of Economics, University of Innsbruck SOWI Building, Universitaetstrasse 15 6020 Innsbruck, Austria // Max Planck Institute of Economics, ESI Group, Kahlaische Str. 10, D-07745 Jena, Germany)
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)

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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.

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Publisher Info
Paper provided by Universitätsbibliothek Wuppertal, University Library in its series Schumpeter Discussion Papers with number sdp09006.

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Length: 27
Date of creation: Jun 2009
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Handle: RePEc:bwu:schdps:sdp09006

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Related research
Keywords: The Modigliani-Miller Theorem; Experimental Study; Decision Making under Uncertainty; General Equilibrium;

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Find related papers by JEL classification:
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March. [Downloadable!] (restricted)
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  2. Davenport, Michael, 1971. "Leverage and the Cost of Capital: Some Tests Using British Data," Economica, London School of Economics and Political Science, vol. 38(150), pages 136-62, May. [Downloadable!] (restricted)
  3. Masulis, Ronald W., 1980. "The effects of capital structure change on security prices : A study of exchange offers," Journal of Financial Economics, Elsevier, vol. 8(2), pages 139-178, June. [Downloadable!] (restricted)
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This page was last updated on 2009-11-9.

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