Modiglani-Miller hypothesis

Popular Terms
Proposition that (in an efficient capital market) a firm's cost of capital is independent of the type of capital employed. Thus, whether a firm uses debt, sale of ordinary shares (common stock), retained earnings (instead of distributing profit as dividends), or any combination thereof to finance its capital needs, its market value is not affected. This concept emphasizes that what investors look for is the quality of earnings, expected rate of return, and the associated risks, not what is the firm's dividend policy or how leveraged (see Leverage) it is. Therefore, the fact that firms still worry about these matters reflects the imperfection of the capital market and effect of the government's taxation policies.
Named after its Nobel laureate proposers, Italian economist Franco Modigliani (1918-) and the US economist Merton H. Miller (1923-).


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