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.”
INVESTOPEDIA EXPLAINS '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 ...

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 >> 
Why would a company use a form of longterm debt to capitalize operations versus ...
A firm that needs money for longterm, general business operations can raise capital through either equity or longterm debt. ... Read Full Answer >> 
What are some common cashdebt strategies that occur during a spinoff?
Cashdebt strategies that are commonly used to in a spinoff to enable the parent company to monetize the spinoff are debt/equity ... Read Full Answer >> 
Why should investors be wary of off balance sheet financing activities?
Investors should be wary of companies that rely heavily on offbalancesheet financing because it may make those businesses ... Read Full Answer >> 
What are financial risk ratios and how are they used to measure risk?
Some of the financial ratios that are most commonly used by investors and analysts to assess a company's financial risk level ... Read Full Answer >> 
What are the differences between preference shares and debentures?
There are many differences between preference shares and debentures, with the biggest difference being that a preference ... Read Full Answer >>

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. 
Fundamental Analysis
Understanding the Profitability Index
The profitability index (PI) is a modification of the net present value method of assessing an investment’s attractiveness. 
Economics
What is Neoliberalism?
Neoliberalism is a littleused term to describe an economy where the government has few, if any, controls on economic factors. 
Fundamental Analysis
Explaining the Monte Carlo Simulation
Monte Carlo simulation is an analysis done by running a number of different variables through a model in order to determine the different outcomes. 
Stock Analysis
Should You Short These DebtLaden Stocks?
These stocks have high debttoequity ratios making them prime candidates to short. 
Economics
Understanding Limited Liability
Limited liability is a legal concept that protects equity owners from personal losses due to their ownership interest in the company. 
Fundamental Analysis
Explaining the Empirical Rule
The empirical rule provides a quick estimate of the spread of data in a normal statistical distribution. 
Economics
Explaining Demographics
Demographics is the study and categorization of people based on factors such as income level, education, gender, race, age, and employment.