The Public Corporation as an Intermediary between 'Main Street' and 'Wall Street'

Posted: 10 Aug 2015 Last revised: 12 Dec 2015

See all articles by Ramesh K. S. Rao

Ramesh K. S. Rao

University of Texas at Austin - Department of Finance

Date Written: October 1, 2015

Abstract

In the perfect markets corporate finance theory (Modigliani-Miller), public corporations (firms) have no economic function. Their existence therefore cannot be justified. An unsettling implication is that the extant corporate finance theory applies to an economy in which firms are irrelevant. This research precludes this implication by identifying an economic function for firms in perfect markets. Specifically, I show that firms exist to intermediate between “Main Street” (the real sector that supplies non-financial inputs) and “Wall Street” (the financial sector that supplies cash), and that this intermediation maximizes an investment’s operating cash flows by minimizing the cost of the non-financial inputs. Key implications of this rationale for the firm include: i) an investment’s NPV depends on the firm’s cash holdings; working capital policy is thus an integral part of investment policy, ii) operating characteristics determine the firm’s minimum size (equity capitalization) and “boundaries,” and iii) cash on corporate balance sheets is a “fundamental” for stock-pricing.

Keywords: Public corporations, theory of the firm, corporate finance theory, Modigliani-Miller, corporate cash holdings, stock-price fundamentals, internal-financing

JEL Classification: G00, G30, G32, G12, G39

Suggested Citation

Rao, Ramesh K. S., The Public Corporation as an Intermediary between 'Main Street' and 'Wall Street' (October 1, 2015). Journal of Corporate Finance, 2015, Vol. 34, October, 64-82. Available at SSRN: https://ssrn.com/abstract=2641340

Ramesh K. S. Rao (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-475-8756 (Phone)
512-471-5073 (Fax)

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