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MENTAL MODEL · M6007

Modigliani-Miller Theorem

Modigliani-Miller Theorem
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Version 1.0.0 · Updated 2026-07-28

CORE DEFINITION

The Modigliani-Miller theorem (MM theorem) is an economic theory proposed by economists Franco Modigliani and Merton Miller, and it is the foundation of modern capital structure theory. The theorem posits that, in the absence of taxes, bankruptcy costs, and information asymmetry, and assuming an efficient market, the value of a firm is unaffected by how it is financed. In other words, whether a company chooses to issue stocks or bonds, or adopts different dividend policies, it does not affect the firm's value. Therefore, the Modigliani-Miller theorem is also known as the capital structure irrelevance theorem. Modigliani received the 1985 Nobel Prize in Economics, and Miller, along with Harry Markowitz and William Sharpe, received the 1990 Nobel Prize in Economics.

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The Modigliani-Miller theorem (MM theorem) is an economic theory proposed by economists Franco Modigliani and Merton Miller, and it is the foundation of modern capital structure theory. The theorem posits that, in the absence of taxes, bankruptcy costs, and information asymmetry, and assuming an efficient market, the value of a firm is unaffected by how it is financed. In other words, whether a company chooses to issue stocks or bonds, or adopts different dividend policies, it does not affect the firm's value.

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Under the perfect capital market assumptions (no taxes, no transaction costs, symmetric information, no bankruptcy costs), the market value of a firm equals the present value of the future cash flows of its assets, regardless of whether it is financed by equity or debt. Because investors can 'replicate' any capital structure themselves (homemade leverage), arbitrage forces valuations to converge across different financing methods.

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