The application of the Modigliani-Miller theorem to Japanese industry
The purpose of this thesis is to study some aspects of Japanese corporate finance, using the analytical tools of the Modigliani-Miller theorem. The Modigliani Miller theorem is a fundamental element in the theory of finance, and establishes the conditions under which the financial structure of the firm is irrelevant to the determination of real corporate values. In its simplest form the theorem requires the presence of perfect capital markets. In the real world,- however, in which perfect capital markets dont exist the validity of the theorem depends upon a number of additional restrictions which can be viewed as special case extensions of the general form. One set of sufficient conditions ensuring the validity of the theorem, is obtained by imposing the assumption of riskless debt. Large groups of major Japanese corporations can be characterized as operating virtually free of bankruptcy risk. The thesis attributes this to the Japanese system of values underlying economic relationships, to the system of corporate groupings (known as keiretsu), and to the strategic objectives of industrial policy which provide industry with a safety-net. It argues that the popular belief that Japanese industry is subject to excessive risk exposure because of its high degree of leverage is misleading. The belief arises from data based on accounting conventions which distort the true position of firms own wealth. The thesis undertakes an empirical study of the validity of the MM theorem. Although the focus of the analysis is on the period 1978-80, the study is run on a second and very different time period, 1970-72. The major finding for the most recent period is that debt, after adjustment for tax advantages, makes no significant contribution to the valuation of companies in keiretsu groups. Interestingly, however, in the earlier period debt is found to make a positive and significant contribution to valuation.