Modigliani-Miller Theorem - M&M

A financial theory stating that the market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends. Remember, a firm can choose between three methods of financing: issuing shares, borrowing or spending profits (as opposed to dispersing them to shareholders in dividends). The theorem gets much more complicated, but the basic idea is that, under certain assumptions, it makes no difference whether a firm finances itself with debt or equity.

In "Financial Innovations and Market Volatility" Merton Miller explains the concept using the following analogy:

"Think of the firm as a gigantic tub of whole milk. The farmer can sell the whole milk as is. Or he can separate out the cream and sell it at a considerably higher price than the whole milk would bring. (That's the analog of a firm selling low-yield and hence high-priced debt securities.) But, of course, what the farmer would have left would be skim milk with low butterfat content and that would sell for much less than whole milk. That corresponds to the levered equity. The M and M proposition says that if there were no costs of separation (and, of course, no government dairy-support programs), the cream plus the skim milk would bring the same price as the whole milk."


Investment dictionary. . 2012.

Look at other dictionaries:

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  • Modigliani, Franco — born June 18, 1918, Rome, Italy died Sept. 25, 2003, Cambridge, Mass., U.S. Italian born U.S. economist. He fled fascist Italy for the U.S. in 1939 and earned a doctorate from the New School for Social Research in 1944. He taught at several… …   Universalium

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