Modigliani and Miller

ESSAY ON : CRITISM OF MODIGLIANI AND MILLER HYPOTHESIS For a firm, the most significant everlasting theme is getting the maximum profit is by minimising cost and taking the least risk. Capital Structure refers to the mix of sources from where the long term funds required in a business may be raised, i.e., what should be the proportions of equity share capital, preference share capital, internal sources, debentures, and other sources of funds in the total amount of capital which an undertaking may raise for establishing its business. A bad financing decision may result in many forms of higher direct or indirect costs, such as lowering stock price, higher cost of capital and lost growth opportunities, increased probability of bankruptcy, higher agency cost and possible wealth transfers from one group of investors to another. Therefore how a manager finances a firm becomes a key concept to a firm. The founderstone of this theory is the Modigliani –Miller theory (MM). MM was developed by two economists, Franco Modigliani, a professor at Massachusetts Institute of Technology, and Merton Miller, a professor at University of Chicago Graduate School of Business. By this main contribution, Modigliani won the Nobel Prize in Economics in 1985 and Miller won the Nobel Prize in Economics in 1990. MM postulate in his interview that “we should not try to make our shareholders wealthy by adjusting debt levels, because at least in the somewhat idealized world in which economists operate, and sometimes in practice it will not work. Instead, MM further argues, the company's best capital structure is one that supports the operations and investments of the business. The concept of Modigliani-Miller Theorem holds that a fim’s market value is calculated by the risk associated with the underlying assets of the firm and also on the earnings capacity of the firm. This theory is based on some assumptions that there is a control aspects of shares which are ignored, there are no