Although many other arguments related to dividend

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Unformatted text preview: not paid, investor uncertainty will increase, raising the required return and lowering the stock’s value. Although many other arguments related to dividend relevance have been put forward, empirical studies fail to provide conclusive evidence in support of the intuitively appealing dividend relevance argument. In practice, however, the actions of both financial managers and stockholders tend to support the belief that dividend policy does affect stock value.3 Because we focus on the day-to-day behavior of firms, the remainder of this chapter is consistent with the belief that 2. Myron J. Gordon, “Optimal Investment and Financing Policy,” Journal of Finance 18 (May 1963), pp. 264–272, and John Lintner, “Dividends, Earnings, Leverage, Stock Prices, and the Supply of Capital to Corporations,” Review of Economics and Statistics 44 (August 1962), pp. 243–269. 3. A common exception is small firms, because they frequently treat dividends as a residual remaining after all acceptable investments have been initiated. Small firms follow this course of action because they usually do not have ready access to capital markets. The use of retained earnings therefore is a key source of financing for growth, which is generally an important goal of a small firm. 566 PART 4 Long-Term Financial Decisions dividends are relevant—that each firm must develop a dividend policy that fulfills the goals of its owners and maximizes their wealth as reflected in the firm’s share price. Review Questions 13–3 Does following the residual theory of dividends lead to a stable dividend? Is this approach consistent with dividend relevance? 13–4 Contrast the basic arguments about dividend policy advanced by Miller and Modigliani (M and M) and by Gordon and Lintner. LG3 13.3 Factors Affecting Dividend Policy dividend policy The firm’s plan of action to be followed whenever a dividend decision is made. The firm’s dividend policy represents a plan of action to be followed whenever the dividend decision is made. Firms develop policies consistent with their goals. Before we review some of the popular types of dividend policies, we discuss the factors the are considered in establishing a dividend policy. These include legal constraints, contractual constraints, internal constraints, the firm’s growth prospects, owner considerations, and market considerations. Legal Constraints Most states prohibit corporations from paying out as cash dividends any portion of the firm’s “legal capital,” which is typically measured by the par value of common stock. Other states define legal capital to include not only the par value of the common stock, but also any paid-in capital in excess of par. These capital impairment restrictions are generally established to provide a sufficient equity base to protect creditors’ claims. An example will clarify the differing definitions of capital. EXAMPLE The stockholders’ equity account of Miller Flour Company, a large grain processor, is presented in the following table. Miller Flour Company Stockholders’ Equity Common stock at par $100,000 Paid-in capital in excess of par 200,000 Retained earnings 140,000 Total stockholders’ equity $440,000 In states where the firm’s legal capital...
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This document was uploaded on 01/19/2014.

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