QuoteOriginally posted by: hamsterQuoteOriginally posted by: daveangelQuoteOriginally posted by: BullBearQuoteOriginally posted by: daveangelso what is the problem mr bullbear ?A)1. leverage2. dumb assumptions................B)Taxes: The theorem uses the lousy regulation on corporate taxes to show how to screw the State in favor of corporations, i.e., wealth transfer from the State/individuals to Corporations!C)I can try to reformulate [metaphorically] the theorem to a more current theme, as follows:Consider 2 otherwise equally "wealthy" countries:a. Country A with no debt [e.g. China]b. Country B almost bankrupt and hence with a pile of debt [e.g. UK]Theorem: The debt/savings mix is irrelevant when an investor is deciding where to put his money / savings... So an investor should be indifferent while choosing to invest his savings in China or in the UK.I think you have a fundamental misunderstanding of M&M I (or more likely you dont and are just trying to be provocative). all this says is that the value of a firm or enterprise is independent of the way it is financed. the firm consists of assets (factories, people, brands) on the one side and liabilities and equity on the other. if there are no taxes and bankruptcy laws then the lhs (asset side) is independent of the mix of equity and debt. in most places interest expense comes above the line ie it is tax deductible meaning that there is an advantage to issuing bonds and int he limit the fim should be 100% debt financed. bankruptcy laws give the debt holders valuable rights but also give equity holders significant optionality. In reality, the conditions udner which M&M I hold cannot be observed anywhere so it is a moot theorem. however, it is a good framework to udnerstand capital structure.I agree 100% with daveangel.here is an alternative hypothesis to mm. It is about ownership and control. if you are equity holder you are owner of the firm and controls it, e.g. fire the manager. the debt and mezz holder disclaim control in exchange for fixed payments whereas rates depends on seniority. if you tell the manager to issue secured debt or some mezz you are increasing the probabilty of loosing ownership and control in exchange for higher average/exspected ROE. The residual payments to the equity fluctuates like hell, the more leverage, i.e. it is more likely you hit threshold of negative equity value. thus equity holder might feel pressured to influence manager's decision regarding buying, selling, enhancing, servicing, valuating the firm's assets. ie at the boundary equity/assets -> 0 the asset value become dependent of the capital structure. bullbearA) you might click here http://www.jstor.org/stable/1809766
and look at the date. 1958 !!! Half a century ago !!! Actually the first thoughts about worth of assets and the capital structure were made by Williams in the 30s. Whatever. the good point is that MM list all their ("dumb") assumptions. it is commonly known that assumptions are not the reality, many people spent a couple of decades relaxing them. B) you are little bit right. Why are interest payments to debt and mezz considered as costs? An accountant might explain it to you. But dont ask why. Accounting rules prefer equity holders. I suspect bcoz of historical reasons assuming equity holders are always entrepreneurs. Another reason is our monetary system which requires an incentive to borrow money. C) indeed debt/savings is irrelevant bcoz savings=debt. you have to invest savings (otherwise it's called hoarding=useless cash) what is mainly offering credit to someone else at the end of the day. even if people of one territory invest their savings somewhere around the world, they can use their capital income to pay taxes in order to serve their public debt at home. you might try the value of exspected GNP instead of savings.This is my view:A) It doesn't matter when things were written it matters if they're still in academic curriculums or if bad quality theory hasn't still been rejected. You can teach useless theorems that used dumb assumptions in "History of Finance" not in "Finance".B.1) This is a huge problem: fragmentation of ownership. If equity is so disperse shareholders are not in control of managers. You get dependent of the decisions of a Board of Managers that may not be alligned with your interests and since equity is so disperse equity holders get lenient and let things go... A model with weak ownership is bad! Believe me. Turning firms into "capital markets" investments or IRA's investments is turning the economy into a giant casino full of gamblers. A firm always needs strong ownership. If there's a place where "democracy" is bad for society this is the case!B.2) Interest payments are well considered as costs. I fully agree with the accountants in this case. The problem here is fiscal. There's an incentive to over-leverage to get fiscal benefits. To me this is non-ethical. In the limit we'll get an incentive from the state to hold 100% debt as individuals and as corporations. Where do we get in the limit? To an unstable financial system with 100% debt and no savings that depends on Ponzi Schemers Central Bankers and Bankers printing paper money to keep the scheme running until 1. one day the future generations get screwed and/or 2. current generation depositors get screwed [by 1. asset bubble and 2. unstable financial system that can cause a bank run and wipe them out]!C.1) "savings = debt?" God, depositors are so screwed. Who do you think will finance a country or an over-leveraged economy?C.2) "you have to invest savings" People with savings don't want to hold any kind of risk! They're paid what? .1%/year? What kind of risks are they being paid for? Do you think deposits are always guaranteed by a printing machine? What's the power of argumentation of small savers regarding interest rates, financial system safety and price stability? None...C.3) This can hold in a closed economy where the "small guy" cannot argue with "power" but when it turns to external debt my friend you'll see the importance of how much leverage is there in a country/economy. Just check what's happening in Greece, Portugal, Spain and elsewhere...C.4) In this kind of system with so much leverage there's no risk free asset... Now imagine a retiree or a unempoyed guy, your young son that might get screwed because there's no safety in the system and you/he can't leave a risk-free reserve to him.C.5) Savings are the same of Reserves. I think that this consumist society forgot basic principles. People with savings hold them with the purpose of Reserves not anything else. What? Do you think people hoard cash to adore it? Everybody would like to live a great life everyday consuming everything but we just can't. First we need to earn it, then you can spend it! You can't leverage yourself for 30/40 years and screw the system if you get out of work. Let depositors or corrupt Bankers solve your problem. People save because they will need the money in the future and they can't afford to loose it otherwise they would apply it according to their decisions.D) This is a pure consumption society with irresponsible Bankers and Central Bankers. The Western Financial system will collapse! I'm sure about it.We're living in a world where the (E) may be a (D). People got a loan from an irresponsible Banker and used it in a firm as a (E). We can get to the limit where everything's a (D) in our economy, only savings are real (E). Do you know what it means to say (E) = 0? It's complete bankrupcy! Right now, the only "real" (E) available are savings and Depositors are holders of junk bonds without being aware of it! Moreover, they're being paid what? 0.1%? 1%? For holding a junk bond?E) Look at the USD/CHF chart. See how people behave when we live in such an unstable system. Why is there such a demand for CHF's nowadays? People are crazy coz' they are desperate to find a safe-haven...F) If 90% of people are holders of debt and 10% hold net savings, and since we live in Democracy we're getting to the point where a debt-overhang society can behave as a virus, using politics, until the last saver gets screwed.