New York Times: Franco Modigliani, 85, Nobel-Winning Economist, Dies. The great man’s presence at the Sloan school was always felt, though I don’t believe I ever actually met him.
The obituary emphasizes his economic research in life-cycle theory, but my corporate finance professor structured much of the theoretical side of our class around the Modigliani-Miller Theory, which said that, except in certain edge cases, a firm’s choice between financing growth with equity or debt is largely meaningless because the specific capital structure (ratio of debt to equity in a firm’s balance sheet) is irrelevant. The theory says that certain common modes of corporate thought are fallacies, including “debt is cheaper than equity,” “taking on debt is better if your earnings per share growth is up, and the weighted average cost of capital should be higher for highly leveraged companies because of the risk to equity. (You may still see some of these fallacies in business journalism or hear them from your boss.)
Of course, this being MIT, we then spent the rest of the semester exploring cases in which Modigliani-Miller ignored certain frictions of the market, including the effect of debt on a firm’s tax burden (it decreases it) and the potential costs of financial distress should a firm be unable to repay its debts.