Fisher's Separation Theorem and its Limitations

Abstract

When businesses make investment decisions, they often evaluate the Net Present Value (NPV) of investment projects. For investors, a project is deemed worthwhile if its NPV is greater than zero. This phenomenon can be attributed to the Fisher Separation Theorem, which asserts that in perfectly efficient capital markets without transaction costs, a single interest rate prevails. In this context, investors' production choices adhere strictly to objective market regulations aimed at maximizing attainable wealth, entirely detached from individual subjective preferences. This, in turn, enables both borrowers and lenders to base their consumption and investment decisions on the prevailing market interest rate, thereby encouraging a clear distinction between investment and financing choices. Therefore, a company's investment decisions can be discussed separately from its financing decisions. So, the enterprise's investment decision and financing decision can be discussed separately. When enterprises invest, enterprises do not have to consider the subjective consumption preferences of different investors, because investors' consumption preferences can be satisfied accordingly through perfect capital market operation. Because of Fisher's Separation Theorem, which requires the market to be transaction cost-free, it also has some limitations.