The Modigliani-Miller (MM) Theorem and the Coase Theorem are two of the most important contributions to modern economics.  Their insights earned Nobel Prizes for their authors, with MM transforming how economists and legal scholars analyze corporate financial policy and Coase doing the same for the analysis of property rights, externalities, and contracting to foster the efficient use of real resources.

The theorems appear similar insofar as both describe idealized conditions under which variables of economic interest are irrelevant.  In MM, the capital structure and dividend policy chosen by a firm do not affect firm value, while in Coase, the initial allocation of property rights does not affect the equilibrium allocation of those rights.  Their shared irrelevance framing suggests the theorems are closely related, with Coase providing a general irrelevance result and MM simply providing an application of Coase’s logic to financial policy – a claim that has been advanced by various authors over the years; see, e.g., Medema’s (2020, section 6.3) comprehensive analysis of research on the Coase Theorem.

In a new paper, we argue that – despite their apparent similarities – the MM and Coase theorems provide conceptually distinct insights for analysis of corporate financial policy and governance that are driven by substantively different economic considerations, with neither theorem a special case of the other.  Our analysis also challenges prevailing wisdom that Coase’s main contribution is the provision of a general result about the irrelevance of endowed allocations when contracting is costless (Medema (2020, p. 1046), Thaler and Imas (2025, pp. 70-72)).  Coase’s far more important insight is his recognition of the pervasive role of opportunity-cost pressure in fostering allocative efficiency in real-world – i.e., costly – contracting environments.  Indeed, Coase’s insight about opportunity-cost pressure is of such power and generality that his theorem deserves to be viewed as foundational bedrock for agency theory and analysis of corporate governance problems in the same way that MM’s theorem is viewed as foundational for analysis of financial policy.

The notion that the MM Theorem nests as a special case of the Coase Theorem is easily refuted because Coase assumes costless contracting, while MM’s conclusion holds in incomplete capital markets where the costs of trading some patterns of state-contingent claims are prohibitively high.  The essential conditions for the MM Theorem to hold are: fixed investment by the firm, no taxes, strong-form market efficiency, frictionless trading of securities by price-taking investors, and the absence of firm-specific monopoly power in security supply.  The MM Theorem is consistent with, but does not require, the far more powerful (Coasian) ability to negotiate and enforce minutely detailed contracts at zero cost.

The MM and Coase theorems also differ in that they advance incompatible claims about the endogenous decisions they analyze.  MM establish that firm value is constant for all feasible debt-equity and dividend decisions and is determined by the firm’s (assumed-to-be-fixed) investment decisions.  All feasible financial decisions are equally good, which means they are indeterminate.  In Coase, by contrast, the optimal allocation of resources is strictly determinate and is always selected in equilibrium when contracting is costless regardless of who initially has the property rights to make decisions.

The crux of the difference is that opportunity-cost pressure in Coase leads contracting parties to arrive at the uniquely optimal set of decisions whereas, in MM, no such pressure is at work to induce the firm to select any specific financial policies.  Opportunity-cost pressure refers to incentives that contracting parties have to capture net gains, or avoid net losses, by avoiding strictly suboptimal decisions.  In MM, the indeterminacy (or “irrelevance”) of a firm’s financial choices follows from the “pie-slicing” nature of those choices when investment is fixed, taxes are absent, and capital markets are strong-form efficient and competitive.  Financial decisions simply divide a given total cash-flow pie into slices with different shapes, and markets rationally price each slice so that the constituent present values always sum to the same total.  When all feasible choices yield the same total market value, as they do under MM’s pie-slicing conditions, there is no opportunity-cost pressure present – or needed – to shape the firm’s financial choices.

The most important difference between the MM and Coase theorems concerns the distinct lessons they provide for corporate finance outside their theoretical settings.  The key lesson from MM is not that financial policy is irrelevant.  Rather, it is that investment policy is the foundational driver of firm value and that financial policy potentially matters because of factors that MM do not consider.  This lesson is well understood in the literature, central to basic textbook discussions of corporate financial policy, and the foundational premise of the most important contributions to modern corporate finance theory, including the early pathbreaking work of Robichek and Myers (1966), Jensen and Meckling (1976), Myers (1977), Myers and Majluf (1984), and Jensen (1986).

In sharp contrast, the important lesson from Coase is often misunderstood.  Coase’s key lesson does not concern the irrelevance of the initial assignment of corporate decision rights.  Rather, his crucial point is that opportunity-cost pressure to improve allocative efficiency is a pervasive phenomenon.  Most corporate finance theory is grounded in the Fisher Separation principle, which indicates that firm value is a proper index of the welfare of a firm’s owners.  Consequently, in a corporate context, opportunity-cost pressure to improve allocative efficiency typically implies pressure to increase firm value.  Opportunity-cost pressure exists whenever choices matter and is not at work when a firm’s choices are all equally good, e.g., as with the financial decisions analyzed by MM.  It is not limited to costless contracting settings, and it applies to all aspects of corporate decision-making, not just those involving externalities.

Coase’s analysis moves corporate finance theory beyond basic recognition of the importance of value maximization and agency problems.  It identifies the ongoing economic pressure to avoid the value losses that inevitably arise in the real world of limited information, costly transacting, and imperfectly aligned incentives.  This insight shifts the focus of research to acknowledge not only the prospect of such losses, but also the emergent nature of the value-increasing corporate governance behavior – including both private contracting and legal rulings – that arises to mitigate losses as efficiency gains become apparent.

The archetypal agency theory example of Coasian opportunity-cost pressure is the price-protection mechanism in Jensen and Meckling (1976), in which security prices reflect expected agency costs and create incentives for firms to design and market securities that motivate managerial behavior that is better aligned with the interests of a firm’s owners.  Other examples of opportunity-cost pressure are the governance mechanisms that drive incentives for managers to increase firm value, including the disciplinary role of the corporate control market (Manne (1965)), shareholder activism (Denes, Karpoff, and McWilliams (2017), Brav, Jiang, and Li (2022)), board monitoring (Coles, Daniel, and Naveen (2024)), and incentive compensation (Jensen and Murphy (1990)).

We begin our paper with a discussion that highlights how Coase’s opportunity-cost logic regarding externalities applies to contracting problems generally.  We then discuss the MM Theorem and delineate its cosmetic similarities to – and substantive differences from – the Coase Theorem.  We go on to analyze what the literature has said about the relation between the two theorems and conclude the paper with a short summary of key points.

Harry DeAngelo is the Kenneth King Stonier Chair Emeritus at the University of Southern California’s Marshall School of Business, and Jonathan M. Karpoff is the Washington Mutual Endowed Chair in Innovation at the University of Washington’s Michael G. Foster School of Business. This post is based on their recent paper, “MM, Coase, and Corporate Finance,” available here.