Modigliani and Miller

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Franco Modigliani and Merton Miller, the authors of an important series of papers from 1958 to 1969 on capital structure and related matters, often referred to as MM or M&M.

Their names are often equated with their ideas on arbitrage. Namely that at lower levels of debt the total cost of capital for a business is determined by the characteristics of the underlying business rather than by the way in which that business is financed.

Therefore, whatever the proportions of equity and debt in the capital structure, in the absence of taxation the returns to the equity component will adjust to give adequate market returns to the providers of both debt and equity (in relation to the risk accepted) and a constant average total cost of capital.

These ideas were set out in their original work, later expanded and developed to accommodate the benefits of tax-sheltered debt servicing costs and additional costs of financial distress at higher levels of debt, to predict the existence of an optimal capital structure.

See also