DEFINITION of 'Irrelevance Proposition Theorem'
A theory of corporate capital structure that posits financial leverage has no effect on the value of a company if income tax and distress costs are not present in the business environment. The irrelevance proposition theorem was developed by Merton Miller and Franco Modigliani, and was a premise to their Nobel Prize winning work, “The Cost of Capital, Corporation Finance, and Theory of Investment.”
BREAKING DOWN 'Irrelevance Proposition Theorem'
In developing their theory, Miller and Modigliani first assumed that firms have two primary ways of obtaining funding: equity and debt. While each type of funding has its own benefits and drawbacks, the ultimate outcome is a firm dividing up its cash flows to investors, regardless of the funding source chosen. If all investors have access to the same financial markets, then investors can buy into or sell out of a firm’s cash flows at any point.
Criticisms of the irrelevance proposition theorem focus on the lack of realism in removing the effects of income tax and distress costs from a firm’s capital structure. Because many factors influence a firm’s value, including profits, assets and market opportunities, testing the theorem becomes difficult. For economists, the theory instead outlines the importance of financing decisions more than providing a description of how financing operations work.
Miller and Modigliani used the irrelevance proposition theorem as a starting point in their tradeoff theory.

Search Theory
A study of buyers and sellers who cannot instantly find a commerce ... 
Optimal Capital Structure
The best debttoequity ratio for a firm that maximizes its value. ... 
Optimum Currency Area Theory
A currency thoery based on geographical area that adopts a fixed ... 
Freudian Motivation Theory
A sales theory which surposes that consumers choose whether or ... 
Rational Choice Theory
An economic principle that assumes that individuals always make ... 
Labor Theory Of Value
An economic theory that stipulates that the value of a good or ...

Bonds & Fixed Income
Evaluating A Company's Capital Structure
Learn to use the composition of debt and equity to evaluate balance sheet strength. 
Investing Basics
Modern Portfolio Theory vs. Behavioral Finance
Modern portfolio theory and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions ... 
Investing Basics
The Optimal Use Of Financial Leverage In A Corporate Capital Structure
The amount of debt and equity that makes up a company's capital structure has many risk and return implications. 
Investing Basics
Why do Debt to Equity Ratios Vary From Industry to Industry?
Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries. 
Fundamental Analysis
Is India the Next Emerging Markets Superstar?
With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP. 
Stock Analysis
The 6 Worst Technology Stocks of 2015
Learn about the technology sector and how it has performed in 2015. Understand the six worst performing technology stocks by average return in 2015. 
Term
Estimating with Subjective Probability
Subjective probability is someone’s estimation that an event will occur. 
Stock Analysis
5 Things to Know About Planet Fitness Stock
Learn about Planet Fitness and how it has achieved success. Understand five aspects of the company that have made it an attractive investment. 
Investing Basics
Understanding the ModiglianiMiller Theorem
The ModiglianiMiller (M&M) theorem is used in financial and economic studies to analyze the value of a firm, such as a business or a corporation. 
Economics
Explaining Kurtosis
Kurtosis describes the distribution of data around an average.

What is the chaos theory?
The chaos theory is a complicated and disputed mathematical theory that seeks to explain the effect of seemingly insignificant ... Read Full Answer >> 
What is the formula for calculating weighted average cost of capital (WACC) in Excel?
When analyzing different financing options, companies need to look at how much it will cost to fund operations. There are ... Read Full Answer >> 
Why can additional paid in capital never have a negative balance?
The additional paidin capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >> 
What is the utility function and how is it calculated?
In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >> 
What types of capital are not considered share capital?
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >> 
How many votes am I entitled to, if I own ordinary shares of a company?
If an investor owns one ordinary share of a company, that investor is entitled to one vote on all of that company's major ... Read Full Answer >>