ABSTRACT

Theinfluenceoffinancialfactorsoninvestmentandoutputisnotemphasizedin traditionalmacromodelsimplicitlyrootedintheArrow-Debreugeneralequilibriumframework.TheModigliani-Millerirrelevancetheorem(Modiglianiand Miller,1958)providesarationaleforthismodelingprocedurebyshowingthat internalandexternalfundsareperfectsubstitutesininvestmentfinancing.This result,however,isvalidifandonlyifmarketsarecompetitive,transactioncosts arenegligible,andinformationisfreelyavailabletoallmarketparticipants.As Millerhasrecentlypointedout:

Theviewthatcapitalstructureisliterallyirrelevantorthat"nothingmatters"incorporatefinance,thoughstillsometimesattributedtous(andtracing perhapstotheveryprovocativewaywemadeourpoint)isfarfromwhatwe everactuallysaidabouttherealworldapplicationsofourtheoreticalpropositions.Lookingbacknow,perhapsweshouldhaveputmoreemphasisonthe other,upbeatsideofthe"nothingmatters"coin;showingwhatdoesn'tmatter canalsoshow,byimplication,whatdoes.(Miller1988,I00)

Ifsomesortofmarketimperfectionexists,suchastransactioncostsorasymmetricinformation,theirrelevancetheoremnolongerholds,andfinancialfactorsoccupyacentralplaceininvestmentandincomedetermination.