Does capital structure matter? Reflection on capital structure irrelevance theory: Modigliani-Miller theorem (MM 1958)

Abstract

Since the 1950s, corporate financing has been an arena for on-going debates that focus on Modigliani and Miller's pioneering theorems of 1958 and 1963. The main purpose of this paper is to present a critical reflection on the debate around corporate capital structure irrelevance that was triggered by Modigliani and Miller theorem in 1958, while taking in consideration the literature, theoretical and empirical findings and the recent global financial crisis (i.e. debt crisis). The paper will briefly review and discuss alternative theories of capital structure, such as the traditional view, the trade-off theory and the pecking order theory in light of reality and perfect capital market hypothesis. The paper starts by defining the concept of capital structure, followed by discussing the assumptions of perfect capital markets under which 'the Modigliani and Miller's irrelevance theory' was originally conceptualised. It finally reflects on the findings before proceeding with the paper's conclusion.