Untaxing Part II: Examining Modigliani-Miller’s Capital Structure Irrelevance Principle
Trillions of dollars in lost tax revenue is too much money not to be clear on the comparison between debt and equity.
Debt actually suppresses the equity-producing power of the public company.
First, we examine the capital structure using the Modigliani-Miller Theorem (1958).
The Modigliani-Miller theorem (of Franco Modigliani and Merton Miller) forms the basis for modern thinking on the capital structure of the public company. This theorem also known as the Capital Structure Irrelevance Principle states that debt and equity can be used interchangeably to finance the public company.
The main problem with the Modigliani-Miller theorem is that it permits the assumption that debt is a fundamental component of capitalism.
Let’s be clear. It is not the intention here to debate the merits of the excellent Modigliani-Miller Theorem which contributes to the focus on the public company capital structure. However, since debt is one of the pillars of this Theorem, students of economics and finance are left with the false belief that debt is part of the concept of capitalism and that they are supported in this belief by two Nobel Prize winners (Modigliani, 1985; Miller, 1990).
We need now to correct this false belief and reliance on debt.