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The Value of the Firm Under Regulation

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  • Jeffrey F. Jaffe
  • Gershon Mandelker

Abstract

The basic theoretical relationships between the value of the firm and leverage were set forth by Modigliani and Miller (MM). Much work has tested the MM relationships empirically, including studies which used data from regulated industries. Gordon has stated that, because earnings before interest and taxes are not held constant in regulated industries, the MM formula used in empirical work is invalid. However, Elton-Gruber (EG) challenge Gordon’s statement. The present paper shows that both the Gordon and the EG formulae hold only under special conditions. Under "normal" conditions of demand, both formulae underestimate the value of the levered firm. We show that there is no a priori method of estimating the effect of leverage on the value of a regulated firm without knowledge of specific supply and demand conditions. As researchers do not usually know these conditions, the results of papers testing the MM propositions with data on regulated industries are ambiguous. General formulae for the discount rate and the valuation of a levered firm in a regulated industry are presented.

Suggested Citation

  • Jeffrey F. Jaffe & Gershon Mandelker, "undated". "The Value of the Firm Under Regulation," Rodney L. White Center for Financial Research Working Papers 14-75, Wharton School Rodney L. White Center for Financial Research.
    • Handle: RePEc:fth:pennfi:14-75
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    Cited by:

    1. Mariko SHIMIZU, 2019. "Why do high ability people also suffer from money illusion? Experimental evidence of behavioral contradiction," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(1(618), S), pages 5-22, Spring.
    2. repec:agr:journl:v:1(618):y:2019:i:1(618):p:5-22 is not listed on IDEAS
    3. Javed Pervaiz & Teng Jian-Zhou & Junaid Masih, 2018. "Long Run Relationship between Selected Macroeconomic Indicators and Banking Sector in Pakistan," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 10(2), pages 67-81, February.

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