'Critique on Mm Theory Essay\r'

'It does non matter what the unbendable’s dividend policy is (Modigliani and Miller 958). The basic assumptions of MM possibleness ar: 1 . The caller only has the long-term bonds and common stocks, both bonds and stock trade in the contend crown market with no exercise cost; 2. The individual investors and corpo pose investors could authorize the same interest rate with no liability risk; 3. The companies with similar run conditions have the same lineage risks; 4. Investors wet-nurse the same expectations on the average business profit in future; 5.\r\n every cash flows atomic number 18 perpetual annuities, including EBIT (Earnings in front interest and measure) etc. that is, the growth ate of the go-ahead is zero (Modigliani and Miller 1958). The development of MM surmisal mostly experienced trey stages: 1 . No- revenue puzzle. The first MM nonplus takes no account of corporate revenueations; 2. corporate tax model. Modigliani and Miller (1963) publish ed corporeal Income Taxes and the Cost of Capital: A Correction, which loosened its initial assumptions, introduced corporate tax into MM conjecture(Modigliani and Miller 1963); 3.\r\nMiller model. Merton H. Miller (1976) proposed to interpret corporate tax and individual tax in estimating how the debt leverage impacts the value of firm (Miller 1977). During the past 50-year, MM theory has do tremendous academic achievements for western sandwich companies in exploring the optimal slap-up social structure and trim down capital costs etc. start-offly, it provides a research frame of reference and notional basis. Since that, most of the capital theories ar rootage on MM theory, such as Pecking- roam Theory, Trade-off Theory, and Agency Theory etc.\r\nSecondly, MM theory makes the capital structure theories systematic and builds a framework for the development of capital structure theories. Secondly, MM theory makes the capital tructure theory systematically, as there was not a system of traditionalistic capital structure theory. Last, but not least, it is only a general definition of the traditional capital structure theory. period MM theory uses modern analytical methods, such as partial equilibrium, numerical analysis etc, therefore, it makes MM theory fashion reliable.\r\nDespite tremendous achievements, there argon save cumberations in MM theory. First, the assumptions argon too harsh, and most of them cannot be achieved in reality. To illustrate, MM theory assumes that individuals and potbelly stoves could borrow at the ore than what corporations do, as hearty as incorporate a higher(prenominal) risk. Furthermore, MM theory also assumes there is no effect cost, which extremely differs from the real transaction process. Second, the assumptions are beyond the reality, although the logic derivation is correct, the conclusions still differs.\r\nBoth corporate tax model and Miller model suppose that corporation should raise the liability a s a good deal as possible in order to maximise the value of the firm, in extremity, up to 100% liability. However, none of endeavours adopt this point. Third, MM theory stands at a quiet erspective, and does not consider the external sparing environment and the impact on capital structure by changing enterprise’s production and operating conditions. In fact, many factors, which affect the capital structures, are variable.\r\nFor example, companies should cut down their liabilities appropriately in order to reduce business risks, when the socio-economic experiences a recession. According to MM theory, the value of tax saving is associated with the corporate income tax rate. That is, the higher corporate income tax rate, the more tax deductible the corporation could achieve from funding by liability. In other words, corporations are inclined to finance by liabilities instead than equity finance in recounting higher corporate income tax rate countries, and vice versa.\r\ nUnder the actual attitude in China, the corporate income tax is often higher than other countries in the reality; corporations should prefer financing from debt theoretically (Huang and Zhang 2007). However, actually, the capital structure of Chinese enterprises runs counter to the MM theory and other capital structure theories. The comparison of liability financing in China is far less than the proportion of equity financing (Huang and Song 2006). First of all, there is merely no appliance in applying MM theory.\r\nIn pact with the MM theory, both individual and institutional investors can process arbitrage actions freely in the capital markets. In western well-developed capital markets, there is a huge range of fund-raising channels and other financing options, the arbitrage mechanisms usually affect the markets. However, at present, the market mechanism is not fully developed in China, as well as capital market is under-developed. Thus, these limit the financing options and forms; make it difficult to go for out arbitrage activities. Generally, MM theory cannot be applied.\r\n'