Like CAPM, the perfect capital market
assumptions result in the Irrelevance Propositions appearing tautological.
Since previous studies considered investment only, we cannot exclude the possibility that other factors (e.g., fixed costs of adjustment capital, irreversibility in capital, etc.) may be responsible for data not conforming to the model's prediction, hence finding the neoclassical model, with the perfect capital market
, to have been misspecified.
Proof: Assume that preferences are homothetic, real prices, constant income [= m], a perfect capital market
, and that firms face menu costs large enough so they cannot increase their current profit by changing price.
In a perfect capital market
, acting through the market allows non-innovating agents to diversify their risks.
Perfect capital market
integration requires that arbitrage profits are zero for trading of any country B security and its perfect substitute in country A; therefore
These findings are broadly inconsistent with the perfect capital markets
model, but fit well with an agency model where managers have career concerns.
Under the theory of perfect capital markets
, a firm should distribute all earnings it does not need in the immediate future and simply issue more equity to finance new initiatives.
The assumption of perfect capital markets
ensures that firms have access to an unlimited supply of funds at a constant cost of capital.
Ezzel, 1980, "The Weighted Average Cost of Capital, Perfect Capital Markets
and Project Life: A Clarification" Journal of Financial and Quantitative Analysis, 15/3, pp.
Under perfect capital markets
, an MM analysis implies a null hypothesis that organizational form and restructurings are irrelevant to firm value.
MM posited in a 1958 paper that, assuming perfect capital markets
and tax neutrality, a firm's mix of debt and equity doesn't affect its value.
Their Proposition I stated that, in equilibrium and given perfect capital markets
without taxes, the value of a firm was independent of its choice of capital structure.