Modigliani-Miller Theorem

Overview

The Modigliani-Miller theorem (1958) establishes that in perfect capital markets, firm value is independent of capital structure. This irrelevance result serves as the benchmark — every real-world reason capital structure matters is a violation of MM's assumptions.

When to Use

• Evaluating whether a financing decision creates or destroys value
• Identifying which market imperfections make capital structure relevant
• Calculating the value of the tax shield from debt
• Teaching or analyzing the logical foundations of capital structure theory

When NOT to Use

• As a literal prescription — real markets are never frictionless
• When the analysis requires explicit bankruptcy cost modeling (use tradeoff theory)
• For financial institutions where capital structure is regulated