Slicing the Pizza in Perfect Capital Markets

Thursday, August 18th, 2005

In Slicing the Pizza in Perfect Capital Markets, Arnold Kling cites an interview with Merton Miller, who explains his work on the irrelevance of capital structure — whether you fund a firm through stocks or bonds:

People often ask: Can you summarize your theory quickly? Well, I say, you understand the M&M theorem, if you know why this is a joke: The pizza delivery man comes to Yogi Berra after the game and says, Yogi, how do you want this pizza cut, into quarters or eighths? And Yogi says, cut it in eight pieces. I’m feeling hungry tonight.

Everyone recognizes that’s a joke because obviously the number and shape of the pieces doesn’t affect the size of the pizza. And similarly, the stocks, bonds, warrants, etc., issued don’t affect the aggregate value of the firm. They just slice up the underlying earnings in different ways.

…Reporters would say, you mean they gave you guys a Nobel Prize for something as obvious as that? [Lots of laughter.] And I’d add, Yes, but remember, we proved it rigorously.

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