# Merton Miller

Merton Howard Miller (May 16, 1923 – June 3, 2000) was an American economist. He won a Nobel Prize in Economics, together with Harry Markowitz and William Sharpe in 1990, for his pioneering work in the field of corporate finance theory. Miller also co-authored the famous Modigliani-Miller theorem (known as the M&M theorem) that deals with relationship between a company's capital-asset structure and its market value, for which his colleague Franco Modigliani received the Nobel Prize in economics in 1985.

## Contents

The basic theorem states that the value of a firm is unaffected by how that firm is financed—it does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, this theorem is also often called the "capital structure irrelevance principle." In this work, he not only recognized that which is in a sense obvious if you break it down to the essentials, he was able to apply vigorous empirical and theoretical analyses to the problem and came up with an elegant solution. Miller was recognized as one of the most important developers in the field of corporate finance, and his work continues to inform and stimulate new research in the field. However, as with all economic models, if human nature is not well understood, such that the individual motivations of those involved are taken into account, the model is not a complete account of economic behavior.

## Life

Merton Howard Miller was born on May 16, 1923, in Boston, Massachusetts, the only child of Joel and Sylvia Miller. He entered Harvard University in 1940, following his father who was a Harvard graduate, earning his bachelor's degree in 1944. One of his colleagues at the university was Robert M. Solow, the Nobel laureate in Economics for 1987.

During World War II, Miller worked for several years as an economist in the division of tax research of the United States Treasury Department, and in the Division of Research and Statistics of the Board of Governors of the Federal Reserve System.

In 1949, Miller started his graduate studies, receiving a Ph.D. in economics from Johns Hopkins University in 1952. His first academic appointment after receiving the degree was Visiting Assistant Lecturer at the London School of Economics. In 1953 he started to work as professor at Carnegie Institute of Technology (now Carnegie-Mellon University), in Pittsburgh, Pennsylvania, where he stayed until 1961. At the time, the Institute’s Graduate School of Industrial Administration (now Tepper School of Business) was among the first and most influential research-oriented U.S. business schools. His colleagues at the University were Herbert Simon (Economics Laureate 1978) and Franco Modigliani (Economics Laureate 1985).

In 1958, Miller collaborated with Modigliani to write a paper on "The Cost of Capital, Corporate Finance and the Theory of Investment," first in a series of papers on corporation finance. Miller wrote or co-authored eight books in total, including Merton Miller on Derivatives (1997), Financial Innovations and Market Volatility (1991), and Macroeconomics: A Neoclassical Introduction (1974, with Charles Upton).

In 1961, Miller accepted an appointment on the faculty of the Graduate School of Business at the University of Chicago, where he stayed until his retirement in 1993. He served during 1966-1967 as visiting professor at the University of Louvain in Belgium. In Chicago he continued to work in the area of corporate finance.

In 1969 Miller’s first wife Eleanor died, living him with his three daughters. He remarried; his second wife's name was Katherine.

Miller became a fellow of the Econometric Society in 1975 and was president of the American Finance Association in 1976. He served as a public director on the Chicago Board of Trade 1983-85 and a director of the Chicago Mercantile Exchange from 1990 until his death. He continued to teach after his retirement in 1993.

Merton Miller died in Chicago on June 3, 2000.

## Work

Miller started his work on corporate finance with his 1958 paper, The Cost of Capital, Corporate Finance and the Theory of Investment," which he co-published with his colleague Franco Modigliani. The paper urged a fundamental objection to the traditional view of corporate finance, according to which a corporation can reduce its cost of capital by finding the right debt-to-equity ratio. According to Miller, however, there was no right ratio, so corporate managers should seek to minimize tax liability and maximize corporate net wealth, letting the debt ratio chips fall where they will.

The way in which Miller and Modigliani arrived at their conclusion made use of the "no arbitrage" argument, where arbitrage is defined as the simultaneous purchase and sale of an asset in order to profit from a difference in the price. Their no arbitrage premise assumes that any state of affairs that will allow traders of any market instrument to create a riskless money machine will almost immediately disappear. They set the pattern for many arguments in subsequent years based on that premise.

### Modigliani-Miller theorem

The Modigliani-Miller (M&M) theorem forms the basis for modern thinking on capital structure. The basic theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the M&M theorem is also often called the capital structure irrelevance principle. Miller's analogy to illustrate the principle uses a pizza: cutting a pizza into a smaller or larger number of pieces does not change the underlying amount of pizza.

The theorem was originally proved under the assumption of no taxes. It is made up of two propositions which can also be extended to a situation with taxes. Consider two firms that are identical except for their financial structures. The first (Firm U) is unlevered: that is, it is financed by equity only. The other (Firm L) is levered: it is financed partly by equity, and partly by debt. The M&M theorem states that the value of the two firms is the same.

#### Without taxes

$V_U = V_L \,$

where

$V_U$ is the value of an unlevered firm = price of buying a firm composed only of equity, and $V_L$ is the value of a levered firm = price of buying a firm that is composed of some mix of debt and equity.

To see why this should be true, suppose an investor is considering buying one of the two firms U or L. Instead of purchasing the shares of the levered firm L, he could purchase the shares of firm U and borrow the same amount of money B that firm L does. The eventual returns to either of these investments would be the same. Therefore the price of L must be the same as the price of U minus the money borrowed B, which is the value of L's debt.

This discussion also clarifies the role of some of the theorem's assumptions. We have implicitly assumed that the investor's cost of borrowing money is the same as that of the firm, which need not be true in the presence of asymmetric information or in the absence of efficient markets.

#### With taxes

$V_L =V_U + T_C D\,$

where

• $V_L$ is the value of a levered firm.
• $V_U$ is the value of an unlevered firm.
• $T_C D$ is the tax rate ($T_C$) x the value of debt (D)

This means that there are advantages for firms to be levered, since corporations can deduct interest payments. Therefore leverage lowers tax payments. Dividend payments are non-deductible.

Miller and Modigliani published a number of follow-up papers discussing some of these issues.

## Legacy

Morton Miller was one of the most important researchers in the area of corporate finance. He revolutionized the field, constructing sophisticated theories from numerous separate rules and theories that existed before. Together with his fellow Nobel laureate Franco Modigliani, he developed the famous Modigliani-Miller theorem on capital structure and dividend policy that set up the foundation of the theory of corporate finance. In 1990, Miller was awarded the Nobel Prize in Economic Sciences for his work on the theory of financial economics. He influenced numerous economists who followed after him.

## Publications

• Fama, Eugene F. and Merton H. Miller. 1972. The Theory of Finance. New York, NY: Holt, Rinehart and Winston. ISBN 0030867320
• Miller, Merton H. 1986. The Academic Field of Finance: Some Observations on its History and Prospects. Chicago, IL: University of Chicago
• Miller, Merton H. 1991. Financial Innovations and Market Volatility. Cambridge, MA: Blackwell. ISBN 1557862524
• Miller, Merton H. 1997. Merton Miller on Derivatives. New York, NY: Wiley. ISBN 0471183407
• Miller, Merton H. 1998. "The M&M Propositions 40 Years Later." European Financial Management, 4(2), 113.
• Miller, Merton H. 2005. Leverage. Journal of Applied Corporate Finance. 17(1), 106-111.
• Miller, Merton H. and F. Modigliani. 1958. "The Cost of Capital, Corporation Finance and the Theory of Investment." American Economic Review, 48(3), 261-297
• Miller, Merton H. and F. Modigliani. 1963. "Corporate income taxes and the cost of capital: a correction." American Economic Review, 53(3), 433-443.
• Miller, Merton H. and Myron S. Scholes. 1982. Dividends and taxes some empirical evidence. Chicago, IL: Center for Research in Security Prices, Graduate School of Business, University of Chicago.
• Miller, Merton H. and Charles W. Upton. 1974. Macroeconomics: A neoclassical introduction. Homewood, IL: R.D. Irwin. ISBN 0256015503

## References

• Brealy, Richard A. and Stewart C. Myers. 1984. Principles of Corporate Finance. New York: McGraw-Hill. ISBN 007007383X
• Miles, J. J. Ezzell. 1980. "The weighted average cost of capital, perfect capital markets and project life: A clarification" In Journal of Financial and Quantitative Analysis. 15, 719-730.
• Stern, Joel M., and Donald H. Chew. 2003. The revolution in corporate finance. Malden, MA: Blackwell Pub. ISBN 1405107812
• Stewart, G. Bennett. 1991. The Quest for Value. New York: HarperCollins. ISBN 0887304184