Abstract

Contrary to Modigliani and Miller (1958, MM hereafter), Capital Structure is not irrelevant when we consider a
firm with a dividend payout policy. This article extends the MM capital structure theorem by relaxing the full
payout assumption and introducing retention policy. The theoretical contribution shows that it is possible to
verify the theorem when we suppose an investor who exchanges his initial holding for another portfolio
composed of consumption and investment. The empirical analysis of this new approach is based on a data set of
the USA Electric Utilities and Oil companies for the period 1990-1998. The results show that the relationships
between leverage and firm value are significantly affected by the firm’s payout ratio. This finding is largely
inconsistent with MM’s view that the division of a stream between cash dividend and retained earnings is a mere
detail in dealing with the irrelevance of capital structure.

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