Many years after, in 1958, Modigliani andMiller (M&M) developed one of the most influential theories of capitalstructure known as the irrelevance theorem I. In line with Paton’s (1922)Entity Theory, M proposed that in a world without taxes the market valueof the firm is independent of its capital structure. M theorem 1 addsthat the total value of the firm is equal to the sum of the market values toall suppliers of capital and is therefore unaffected by the size of debt toequity used in its capital structure (Scott, 1976). They explained that theamount of debt within a firm’s capital structure is subject to each individualcompany and everyone is different, concluding that capital structureirrelevant. This fundamental proposition indicates that the aptitude ofinvestors to engage in personal leverage is sufficient to ensure that leverageitself cannot change the overall market value of the firm. This means that thetheorem enables conditions under which arbitrages by individual’s keeps the valueof the firm, depending only on cash flow generated by the investment policy(Mondher, 2011). Moreover, M theorem 1 maintains that any increase inprofitability through higher leverage will be offset by an increase in the unitcost of the remaining equity capital (Cline, 2015).
Myrtle (1993) andFrydenberg (2004) support the notion of M irrelevance theorem(proposition I) that in complete and perfect capital markets, firm value isindependent of its capital structure and that an optimal capital structure doesnot exist when capital markets are perfect with no taxes, no costs ofbankruptcy, together with agency costs. Subsequently Robichek (1966), Baxter(1967), Bierman & Thomas (1972), Kraus & Litzenberg (1973), findevidence that contradict M irrelevance theorem 1 that an internal optimalcapital structure can exist as there is no such existences as the perfectmarket. Consistent with M researches Opler & Titman (1993) evidencedthat M theorem fails under a market with imperfections as in the real-worldtaxes, bankruptcy and transaction costs, along with agency conflicts exist andshould be considered as major explanations for the corporate choice to use debtfinancing. Gordon and Chamberlin (1994) largely support bankruptcy costs andagency costs as determinants for an optimal capital structure and agreeing withTitman (1993) therefore also finds evidence to contradict M irrelevancetheorem 1 under imperfect conditions (Gordon and Chamberlin, 1994, in Mondher,2011).