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Fisher separation theorem

 
Investment Dictionary: Fisher's Separation Theorem

A theory stating that:

1. A firm's choice of investments are separate from its owner's attitudes towards the investments.

2. It is possible to separate a firm's investment decisions from the firm's financial decisions.

Investopedia Says:
This theory says a firm's value is not affected by how its investments are financed or how the distributions (dividends) are made to the owners.

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Wikipedia: Fisher separation theorem
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"Separation theorem" redirects here. For the other separation theorem, see Gabbay's separation theorem.

In economics, the Fisher separation theorem asserts that the objective of a firm will be the maximization of its present value, regardless of the preferences of its owners. The theorem therefore separates management's "productive opportunities" from the entrepreneur's "market opportunities". It was proposed by — and is named after — the economist Irving Fisher.

The theorem has its "clearest and most famous exposition" [1] in the Theory of Interest (1930); particularly in the "second approximation to the theory of interest" (II:VI).

The Fisher separation theorem states that:

  • the firm's investment decision is independent of the preferences of the owner;
  • the investment decision is independent of the financing decision.
  • the value of a capital project (investment) is independent of the mix of methods – equity, debt, and/or cash – used to finance the project.

Fisher showed the above as follows:

  1. The firm can make the investment decision — i.e. the choice between productive opportunities — that maximizes its present value, independent of its owner's investment preferences.
  2. The firm can then ensure that the owner achieves his optimal position in terms of "market opportunities" by funding its investment either with borrowed funds, or internally as appropriate.

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