The Modigliani-Miller Theorem holds that a firm’s market value is calculated by the risk associated with the underlying assets of the firm and also on the earning capacity of the firm.
The theorem further states that the market value of the firm is not affected by the choice of financing the investments or on the decisions of distributing the dividends. The three ways that a firm can select to finance the investments are – borrowing outside capital, issuing the shares and reinvesting the profits.
According to the theory, under some market assumptions whether or not the firm investments are financed with equity or debt makes no difference. The Modigliani-Miller theorem is very often called as the capital structure irrelevance principle.
Economist Modigliani was awarded Nobel Prize in Economics in the year of 1985 for introducing this theory and his other contributions to economic studies.
Last Updated on : 27th June 2013