This case is about the impact of an environmental factor (External issue) on dividend policy of the firm (Internal issue). The environmental disaster was Hurricane Katrina which was caused the huge destruction across the south-eastern United States. Because of the storm, the stock market notably fell down. Since it is possible that the price of the shares once more increase even more than before in the near future, Ashley Swenson, chief financial officer (CFO) of Gainesboro Machine Tools Corporation has the dilemma to buy back stock or to spend the money as dividend the shareholders. In fact, the question is: How can she forecast the fortune of the stock market? In the other …show more content…
Initial ventures into explaining corporate dividend policy are divided as to their prediction of dividend payment’s effects on share prices. Three streams of thinking seem to be offered: One is explaining dividends as attractive and a positive influence on stock price, the second argues that stock prices are negatively correlated with dividend payout levels, and a third avenue of empiricists maintain that the firm’s dividend policy is irrelevant in stock price valuation. In this chapter a brief overview of various theoretical modeling and empirical investigations by financial economists is given. We begin with the third stream of thinking, which is Dividend Irrelevance proposition.
4.4. MODIGLIANI & MILLER APPROACH (DIVIDEND IRRELEVANCE PROPOSITION) (1961)
Dividend policy has been extensively studied within the financial literature .In 1961, two noble laureates, Merton Miller and Franco Modigliani (M&M) showed that under certain simplifying assumptions, a firms’ dividend policy does not affect its value. The basic premise of their argument is that firm value is determined by choosing optimal investments. The net payout is the difference between earnings and investments, and simply a residual. Because the net payout comprises dividends and share repurchases, a firm can adjust its dividends to any level with an offsetting change in share outstanding. From the