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Dividend Policy

Autor:   •  October 31, 2011  •  Essay  •  365 Words (2 Pages)  •  1,791 Views

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Dividend policy is an important and controversial topic in finance. According to Modigliani & Miller Dividend Irrelevance Theorem, the value of the firm is not affected by what the firm's dividend policy is. There are several assumptions in M&M Model which include: (1) there are no taxes or transaction costs; (2) investors are indifferent between dividends and buybacks; (3) the investment, financing and operating policies of the firm are held fixed.

The following hypotheses might influence a firm’s choice of dividend policy:

1. Bird in the Hand Hypothesis

Based on Bird in the Hand Hypothesis (Gorden & Lintner, 1962), investors prefer dividends because dividends now are more certain than capital gains later. This means that dividends are worth more to investors than capital gains (other things are equal). This may be sufficient to offset the potential tax disadvantage of dividends. However, M&M disagrees with this Hypothesis and call this the “bird in the hand fallacy”. Because in absence of transaction cost, the investors who are holding low- dividend stocks but desiring high current cash flow could sell off their shares to obtain required money.

2. Clientele Effect Hypothesis

Relating to tax issues, different investors have different tax positions. Those with high income tax rates will prefer low dividends and vice versa. Firms will tend to attract those investors who like its type of dividend policy (assumes investors do not use ‘homemade’ dividends) Clientele effects encourage firms to maintain stable dividend policies,

because (1) there is no benefit to firm value in changing policy (M&M); (2) if the firm changes policy it will simply lose one clientele and gain another; (3) investors prefer not to be constantly rebalancing portfolios to keep firms with the preferred policy; (4)investors

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