Correction to Modigliani-Miller essay
By Arnold Kling
Thanks to commenter Daniel Davies, I have changed an incorrect word in my Modigliani-Miller essay. It now reads
Before MM, the conventional wisdom was that highly-levered firms (firms that issue a lot of debt relative to equity) offered their investors higher risks and higher expected returns than less-levered firms. MM said that financial structure was essentially irrelevant.
Before, it read “shareholders” instead of investors, which is wrong. “Investors” includes both shareholders and bondholders.
I also think I could have better described the “conventional wisdom” pre-MM. The “conventional wisdom” was that a highly-levered firm could appeal to the risk-tolerant investor and that a relatively unlevered firm could appeal a risk-averse investor. MM showed that this not the case, because investors in levered firms can dial down their risk by owning the bonds issued by those firms.