Modigliani-Miller Theorem - M&M
Categories: Financial Theory
Depending on the day, you might want a bag of delicious, chocolatey M&Ms...or you might want a refresher on the M&M, the Modigliani-Miller Theorem. If today you want the latter—then today’s your lucky day.
The Modigliani-Miller Theorem is the idea that a company’s market value isn’t determined by how they’re financing, but rather on its ability to earn money, and by its risk. Many believe a firm is more stable, and thus more valuable, if it’s financed a certain way. Some firms choose to use profits to invest in itself, while others choose to borrow or sell more shares to shareholders.
The M&M theory says all that doesn’t matter. If a firm is making optimal choices, the value comes from the company itself, and it doesn't matter if the company is debt-financed or equity-financed. At the time this theory was published by the two corporate finance outsiders, it was a new, crazy idea...almost hearsay...which caused it to become extremely popular, and changed many financiers' ideas about how firm financing relates to firm value.