What is Fisher's Separation Theorem?

The Fisher's separation theorem is an economic theory that states that the investment choices or decisions of a firm are independent of the investment preferences of the firms owners. This theorem postulates that a firm should be concerned about maximizing profit rather than trying to achieve the diverging objectives of the firms owners. The Fishers separation theorem also posits that regardless of the preferences of a firms shareholders, the firm should pay attention to optimal production value that will drive higher profits.

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Why is Fisher's Separation Theorem Important?

Fishers separation theorem maintains that the primary goal of a corporation is to maximize profit rather than try to achieve the utility preferences of shareholders. This theorem states that the productive value of a firm should not be affected by the preferences of its owners, neither should the value affect the owners or shareholders preferences. Also called the portfolio separation theorem, Fishers separation theorem holds that the investment decisions of a firm are different from the investment preferences of its owners or shareholders. This theorem identifies that the shareholders of a form have different investment objectives separate from the firms managers. Hence, managers should ignore the utility preferences of shareholders and focus on how to maximize the value or profit of the firm.

Theorem's Extension

The Fishers separation theorem laid a foundation for the development of the Modigliani-Miller theorem. It thrives on the position that the value of a firm is nor affected by the utility preferences of its owner, in an efficient capital market. The Modigliani-Miller theorem postulates that how a company finances its investments or makes dividend distributions does not affect its value. According to this theorem, a firm can finance investments through, equity financing, debt financing, and internally-generated revenue.

Irving Fisher

Fisher's separation theorem was named after Irving Fisher, a Yale-trained economist who developed the theory. Irving Fisher lived between 1867 and 1947, during his lifetime, he contributed tremendously to neoclassical economics be developing theories relating to investment, capital, utility and interest rates.