Scribd
Upload
49 views

Chapte R: Dividend Theory

This document discusses dividend theory and policy. It covers several models for determining the value of a company based on its dividend policy, including Walter's model, Gordon's model, and the Miller-Modigliani hypothesis of dividend irrelevance. It also discusses the bird-in-the-hand argument for paying dividends, market imperfections that make dividend policy relevant, and the informational content of dividend policy decisions.

Uploaded by

Arunim Mehrotra
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
49 views

Chapte R: Dividend Theory

This document discusses dividend theory and policy. It covers several models for determining the value of a company based on its dividend policy, including Walter's model, Gordon's model, and the Miller-Modigliani hypothesis of dividend irrelevance. It also discusses the bird-in-the-hand argument for paying dividends, market imperfections that make dividend policy relevant, and the informational content of dividend policy decisions.

Uploaded by

Arunim Mehrotra
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 19

CHAPTE

DIVIDEND THEORY
R 17
LEARNING OBJECTIVES
2

 Highlight the issues of dividend policy


 Critically evaluate why some experts feel that dividend
policy matters
 Discuss the bird-in-the-hand argument for paying current
dividends
 Explain the logic of the dividend irrelevance
 Identify the market imperfections that make dividend policy
relevant
 Understand information content of dividend policy
INTRODUCTION
3

 Dividend policy involves the balancing of the


shareholders’ desire for current dividends and the
firm’s needs for funds for growth.
Issues in Dividend Policy
4

 Earnings to be Distributed – High Vs. Low


Payout.
 Objective – Maximize Shareholders Return.
 Effects – Taxes, Investment and Financing
Decision.
Relevance Vs. Irrelevance
5

 Walter's Model
 Gordon's Model
 Modigliani and Miller Hypothesis
 The Bird in the Hand Argument
 Informational Content
 Market Imperfections
DIVIDEND RELEVANCE:
6
WALTER’S MODEL
Walter’s model is based on the following assumptions:
 Internal financing
 Constant return and cost of capital
 100 per cent payout or retention
 Constant EPS and DIV
 Infinite time
Walter’s formula to determine the
7
market price per share:
Optimum Payout Ratio
8

 Growth Firms – Retain all earnings


 Normal Firms – No effect
 Declining Firms – Distribute all earnings
Example: Dividend Policy:
Application of Walter’s Model

9
Criticism of Walter’s Model
10

 No external financing
 Constant return, r
 Constant opportunity cost of capital, k
DIVIDEND RELEVANCE:
11
GORDON’S MODEL
Gordon’s model is based on the following assumptions:
 All-equity firm
 No external financing
 Constant return
 Constant cost of capital
 Perpetual earnings
 No taxes
 Constant retention
 Cost of capital greater than growth rate
Valuation
 Market value of a share is equal to the present value
of an infinite stream of dividends to be received by
shareholders.
Example: Application of
13
Gordon’s Dividend Model
It is revealed that under
Gordon’s model:
14
DIVIDEND AND UNCERTAINTY:
THE BIRD-IN-THE-HAND
ARGUMENT
 Argument put forward, first of all, by Kirshman

 Investors are risk averters. They consider distant


dividends as less certain than near dividends. Rate
at which an investor discounts his dividend stream
from a given firm increases with the futurity of
dividend stream and hence lowering share prices.
DIVIDEND IRRELEVANCE: THE
MILLER–MODIGLIANI (MM)
HYPOTHESIS
 According to M-M, under a perfect market situation, the
dividend policy of a firm is irrelevant as it does not affect the
value of the firm. They argue that the value of the firm
depends on firm earnings which results from its investment
policy. Thus when investment decision of the firm is given,
dividend decision is of no significance.

 It is based on the following assumptions:-


 Perfect capital markets
 No taxes
 Investment policy
 No risk
17
Market Imperfections
18

1. Tax Differential – Low Payout Clientele


2. Flotation Cost
3. Transaction and Agency Cost
4. Information Asymmetry
5. Diversification
6. Uncertainty – High Payout Clientele
7. Desire for Steady Income
8. No or Low Tax on Dividends
Informational Content of Dividend
 …. In an uncertain world in which verbal
statements can be ignored or misinterpreted,
dividend action does provide a clear cut means of
‘making a statement’ that speaks louder than a
thousand words. — Solomon

You might also like