Modigliani Miller Theory

Modigliani-Miller is a Nobel Prize winning theory on the capital structure of firms. Modigliani received the Nobel Prize in 1985 and Miller received it in 1990.

Summary of Theory

The value of the firm is independent of its capital structure. Thus, financing decisions are irrelevant.

In an ideal, frictionless world:

• Long-term vs. short-term debt is irrelevant
• Dividend policy is irrelevant
• Private or public equity is irrelevant

If perfect markets, a firm’s cost of capital = the expected return on its assets (Ra) regardless of the firm’s capital structure.

Theory Assumptions:

• Securities markets are competitive and efficient
• Investors and managers have the same information about the firm’s assets
• No taxes
• Firm’s productive assets are held constant