The Modigliani - Miller results are not easy to understand fully. This point is related in a story told by Merton Miller(Taken from from GSB Chicago, University of Chicago, 1986) "
How difficult is to summarize briefly the contribution of the MM papers was brought home to me very clearly last October after Franco Modigliani was awarded the Nobel Prize in Economics part - but, of course, only in part - for the work in finance. The television camera crews from our local stations in Chicago immediately descended upon me. "We understand," they said, "that you worked with Modigliani some years back in developing these M&M theorems and we wonder if you could explain them briefly to our television viewers."
"How briefly?", I asked.
"Oh, take ten seconds," was the reply.
Ten seconds to explain the work of a lifetime! Ten seconds to explain two carefully reasoned articles, each running to more than thirty printed pages and each with sixty or so long footnotes! When they saw the look of dismay on my face, they said, "You don't have to go in details. Just give us the main points in simple, commonsense terms."
The main point of the first or cost-of-capital article was, in principle at least, simple enough to make. It said that in an economist's ideal world of complete and perfect capital markets and with full and symmetric information among all the market participants, the total market value of all the securities issued by a firm was governed by the earning power and risk of its underkying real assets and was independent of how the mix of securities issued to finance it was divided between the debt instruments and equity capital....Such a summary, however, uses too many short hand terms and concepts like perfect capital markets that are rich in connotations to economists but hardly for the general public. So, I thought of an anology...
"Think of the firm," I said, "as a gigantic tub of whole milk, The farmer can sell the whole milk as is. Or he can separte out the cream and sell it at a considerably higher price than the whole milk would bring. (Thats the analogy of a firm selling low yield and hence high-priced debt securites.) But of course, what the farmer would have left would be skim milk with low butterfat content and that would sell for much less than whole milk. That corresponds to the levered equity. The M&M proposition says that if there were on costs of separation, the cream plus the skim milk would bring the same price as the whole milk."
The television people conferred among themsleves and came back to inform me that it was too long, too complicated, and too academic.
"Don't you have anything simpler?" they asked. I thought of another way....
"Think of the firm," I said, "as a gigantic pizza, diviided into quarters. If now you cut each oquarter in hand into eights, the M&M proposition says that you will have more pieces but not more pizza."
Again there was a whispered conference among the camera crew, and the director came back and said: "Professor, we understand from the press releases that there were two M&M propositions. Can we try the other one?"
After I spoke, once again there was a whispered conversation. They shut the lights off. They folded up their equipments. They thanked and left. I knew that somehow I had lost my chance to start a new career as a packager of economic wisdom for TV viewers in convinient ten-second bites. Some have the talent for it...and some just don't.
How difficult is to summarize briefly the contribution of the MM papers was brought home to me very clearly last October after Franco Modigliani was awarded the Nobel Prize in Economics part - but, of course, only in part - for the work in finance. The television camera crews from our local stations in Chicago immediately descended upon me. "We understand," they said, "that you worked with Modigliani some years back in developing these M&M theorems and we wonder if you could explain them briefly to our television viewers."
"How briefly?", I asked.
"Oh, take ten seconds," was the reply.
Ten seconds to explain the work of a lifetime! Ten seconds to explain two carefully reasoned articles, each running to more than thirty printed pages and each with sixty or so long footnotes! When they saw the look of dismay on my face, they said, "You don't have to go in details. Just give us the main points in simple, commonsense terms."The main point of the first or cost-of-capital article was, in principle at least, simple enough to make. It said that in an economist's ideal world of complete and perfect capital markets and with full and symmetric information among all the market participants, the total market value of all the securities issued by a firm was governed by the earning power and risk of its underkying real assets and was independent of how the mix of securities issued to finance it was divided between the debt instruments and equity capital....Such a summary, however, uses too many short hand terms and concepts like perfect capital markets that are rich in connotations to economists but hardly for the general public. So, I thought of an anology...
"Think of the firm," I said, "as a gigantic tub of whole milk, The farmer can sell the whole milk as is. Or he can separte out the cream and sell it at a considerably higher price than the whole milk would bring. (Thats the analogy of a firm selling low yield and hence high-priced debt securites.) But of course, what the farmer would have left would be skim milk with low butterfat content and that would sell for much less than whole milk. That corresponds to the levered equity. The M&M proposition says that if there were on costs of separation, the cream plus the skim milk would bring the same price as the whole milk."
The television people conferred among themsleves and came back to inform me that it was too long, too complicated, and too academic.
"Don't you have anything simpler?" they asked. I thought of another way....
"Think of the firm," I said, "as a gigantic pizza, diviided into quarters. If now you cut each oquarter in hand into eights, the M&M proposition says that you will have more pieces but not more pizza."
Again there was a whispered conference among the camera crew, and the director came back and said: "Professor, we understand from the press releases that there were two M&M propositions. Can we try the other one?"
After I spoke, once again there was a whispered conversation. They shut the lights off. They folded up their equipments. They thanked and left. I knew that somehow I had lost my chance to start a new career as a packager of economic wisdom for TV viewers in convinient ten-second bites. Some have the talent for it...and some just don't.
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