What Is Fisher's Separation Theorem?
Fisher's separation theorem states that the primary goal of any corporation is to increase its present value to the greatest extent possible. The theory contrasts management's focus on productive opportunities with its shareholders' focus on stock market opportunities.
- Fisher's theorem argues that the foremost duty of a company's management is to maximize the company's value.
- This priority conflicts with the first concern of shareholders, which is to reap the rewards of dividends or the sale of shares.
- Fisher argues that a successful corporation will ignore shareholders and go for maximum value.
The theorem is named after American economist Irving Fisher, a professor at Yale University and one of the earliest neoclassical economists, who developed it in 1930.
Fisher's separation theorem is also known as portfolio separation theorem.
Understanding Fisher's Separation Theorem
Fisher's theorem assumes that shareholders not only have different objectives from management but that they lack the deep knowledge of the business' needs and opportunities that is necessary to make decisions that will lead to the company's long-term prosperity.
He argues that management should disregard the wishes of shareholders and focus on productive opportunities. This, in turn, will maximize profits, to the benefit of both shareholders and management.
The theorem can be broken down into three key assertions.
- A company's investment decisions are separate from the preferences of its owners, including its shareholders.
- A company's investment decisions are separate from its financing decisions.
- The value of a company's investments is separate from the mix of methods that can be used to finance the investments, which include taking on debt, issuing shares, or spending cash.
It follows that the attitudes of a company's owners or shareholders are not taken into consideration during the process of selecting investments.
Irving Fisher was a founder of neoclassical economics, which focuses on the analysis of supply and demand as the primary forces driving an economy.
The goal of the company is maximizing profit. Thus, the potential impact on the company's value is the primary consideration for making investment choices.
Fisher's separation theorem concludes that a company's value is not determined by the way it is financed or the dividends that are paid to the firm's owners.
In the early 20th century, Irving Fisher came as close to celebrity status as an economist ever gets. He also was a social reformer who campaigned for a wide variety of causes from pure food and abolition of alcohol to human eugenics.
His career and his personal fortune both took a dive when he predicted, two weeks before the Black Friday market crash of October 1929, that stocks appeared to "have achieved a permanently high plateau."
His contributions to economics have since been recognized. In 1967, economist Paul Samuelson declared that Fisher was "this country's greatest scientific economist." Fisher died in 1947.