An Extension of the Modigliani-Miller Theorem to Stochastic Economies with Incomplete Markets and Fully Interdependent Securities

The Modigliani-Miller theorem is shown to hold in a general model of a multiperiod, stochastic economy with incomplete markets and perfect foresight. In the model, firms are allowed to trade all available securities; thus, share prices and dividends become fully interdependent. Also, several mechanisms of corporate control are considered, including value maximization and shareholder voting. It is demonstrated that firms have no incentive to trade securities in equilibrium; further, any such trading does not alter the set of equilibrium allocations. This is done by establishing that agents are able to adjust their own portfolios and neutralize corporate policy.