When Are Dividends Irrelevant - When Are Dividends...

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When Are Dividends Irrelevant? (The Miller Modigliani Proposition) There is a school of thought that argues that what a firm pays in dividends is irrelevant and that stockholders are indifferent about receiving dividends. Like the capital structure irrelevance proposition, the dividend irrelevance argument has its roots in a paper crafted by Miller and Modigliani. The Underlying Assumptions The underlying intuition for the dividend irrelevance proposition is simple. Firms that pay more dividends offer less price appreciation but must provide the same total return to stockholders, given their risk characteristics and the cash flows from their investment decisions. Thus, there are no taxes, or if dividends and capital gains are taxed at the same rate, investors should be indifferent to receiving their returns in dividends or price appreciation. For this argument to work, in addition to assuming that there is no tax advantage or disadvantage associated with dividends, we also have to assume the following: There are no transactions costs associated with converting price appreciation into cash, by selling stock. If this were not true, investors who need cash urgently might prefer to receive dividends. Firms that pay too much in dividends can issue stock, again with no flotation or transactions costs, to take on good projects. There is also an implicit assumption that this stock is fairly priced. The investment decisions of the firm are unaffected by its dividend decisions, and the firm s operating cash flows are the same no matter which dividend policy is adopted. Managers of firms that pay too little in dividends do not waste the cash pursuing their own interests (i.e., managers with large free cash flows do not use them to take on bad projects). Under these assumptions, neither the firms paying the dividends nor the stockholders receiving them will be adversely affected by firms paying either too little or too much in dividends. A Proof of Dividend Irrelevance
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This note was uploaded on 05/20/2010 for the course DOF AAf001-6 taught by Professor Changchungdo during the Spring '10 term at 카이스트, 한국과학기술원.

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When Are Dividends Irrelevant - When Are Dividends...

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