The Dividend Theory: Financial Irrelevance Theory

Improved Essays
Introduction
The dividend policy is a major financing decision that involves payment to shareholders in return of their investments in a company. Each and every company listed follows some sort of dividend payment pattern and it is obviously a financial indictor of the specific company. Once a company makes a profit, management must decide on what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends. Once the company decides on whether to pay dividends they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets. What they decide depends
…show more content…
Each corporation would tend to attract to itself a clientele consisting of those preferring its particular payout ratio, but one clientele would be entirely as good as another in terms of the valuation it would imply for the firm.”
Dividend Irrelevance Theories:
1) Miller and Modigliani Theorem

They argued that subject to several assumptions, investors should be indifferent on whether firms pay dividends or not. The value of the firm therefore depends on the investment decisions but not the dividend decision and are based on the perfect market assumptions.

2) The Residual Theory

This theory hold the fact that all dividend paid are residual, after the firm has retained cash for available investments and positive NPV projects. This being said it was seen that dividend being only the residual cash available cannot be a factor in movement of share
…show more content…
The model holds that when dividends are paid to the shareholders, they are reinvested by the shareholder further, to get higher returns.

Walter’s formula to determine the market price per share (P) is as follows:
P = D/K +r(E-D)/K/K

Where P – Market price D – Dividend per share E – Earning per share K – Cost of equity r – Rate of return on investment

3) Signaling Theory

Ross (1977) argued that in an inefficient market, management can use dividend payment to signal important information to the market which is only known to them. If management increases dividend, it signals expected high profit and therefore share prices will increase.

4) The Clientele Effect Theory

It was proposed by Pettit (1977) who stated that different groups of shareholders have different preference for dividend. For example the low income earners will prefer higher dividend to meet their consumption needs while the high income earners will prefer less dividend so as to avoid the payment of taxes. Therefore when a firm sets a certain dividend policy there will be shifting of investors to it and out of it until equilibrium position is reached. At equilibrium, the dividend policy set by the firm will be consistent with the clientele it

Related Documents

  • Great Essays

    Introduction Steve Madden Ltd. fashion company designs and markets shoes, apparel, and accessories for women, men, and children. The company includes a number of brands within the franchise. Steven Madden stores have locations both domestically within the United States and internationally. Its’ products are also sold within multiple different department stores and has a large online database to buy from. Despite the company being in the shrinking retail industry, Steve Madden Ltd. continues to grow and expand.…

    • 1091 Words
    • 5 Pages
    Great Essays
  • Improved Essays

    Case study analysis: 33 California Pizza Kitchen Managing for Corporate Value Creation FIN3CSFS2 2015 \ Abstract: This case analysis studies the financial performance and position of California Pizza Kitchen (KPC) including available sources of finance with optimal weightage to cost of capital minimal by share repurchase and their effect on share price and return. Question No. 1 As the history of California Pizza Kitchen (KPC) is concerned, it was incorporated in 1985 In Baverlly Hills, California.…

    • 976 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    BHP Billiton seen proceeded with development in the worldwide economy in spite of critical drops in commodity costs and instability in money and financial markets. BHP Billiton works under a Dual Listed Company (DLC) structure, with two parent organizations BHP Billiton Limited and BHP Billiton Plc worked as a solitary financial entity, keep running by a unified Board and management group. BHP Billiton Limited has a main listing on the Australian Securities Trade (ASX) in Australia. BHP Billiton Plc has a premium listing on the UK Listing Authority's Official List and its ordinary shares are confessed to trading on the London Stock Exchange (LSE) in the United Kingdom and an optional listing on the Johannesburg Stock Trade (JSE) in South Africa.…

    • 321 Words
    • 2 Pages
    Improved Essays
  • Improved Essays

    A good way that investors relations can impact the success of Spartan Mortors, Inc is in measuring how their stock hit the apical point in 20 years time. Their efforts to inform current and future shareholders definitely aided them in their successs. Due to their company growth their market capital was amplified twice over and allowed them Director of Investor Relations: Mining Indaba- London, Ontario In Canada there are many jobs that connect and have affiliates with investor relations.…

    • 384 Words
    • 2 Pages
    Improved Essays
  • Improved Essays

    Hardware Case

    • 741 Words
    • 3 Pages

    Despite the downside, there are some significant advantages associated with the repurchase program. Although the company is expected to earn the risk free rate on its surplus cash by investing in treasury securities, the investors demand a much higher rate on their investments. Therefore, if the company does not have any attractive opportunities in the near future, it might be a good strategy to return the cash to shareholders in the form of share repurchase. Additionally, the share repurchase is also an excellent way to reduce the dividend payout ratio without reducing the dividend per share. There is a strong negative sentiment associated with a decrease in dividend per share, and is usually seen by investors as a sign of weakening performance…

    • 741 Words
    • 3 Pages
    Improved Essays
  • Superior Essays

    Stock Market Influences

    • 1851 Words
    • 8 Pages

    To some, stock market investments make the primary component of an individual retirement portfolio. Enterprises and enterprises become noticeable when they access the stock market with the intention of raising capital for strategic and operational purposes. Stock markets trends have an influence on consumer and corporate willingness to invest thereby controlling United States economy (Arbogast, 2013). By facilitating, trades between companies, consumers and other companies. The stock market provides a platform for growing companies to raise capital at s lower cot which allows them to be less dependent on the bank financing.…

    • 1851 Words
    • 8 Pages
    Superior Essays
  • Improved Essays

    The company I have chosen for this discussion is Hasbro. Hasbro manufactures toys and board games. Since beginning in the 1940s they have become the second largest company in their industry. Their dividend policy is “Declaration of dividends is at the discretion of the Company’s Board of Directors and will depend upon the earnings and financial condition of the Company and such other factors as the Board of Directors deems appropriate” (Goldner, 2016). Dividends paid over the past three years are as follows: $225.8 million in 2015, $216.9 million in 2014 and $156.1 million in 2013.…

    • 413 Words
    • 2 Pages
    Improved Essays
  • Great Essays

    For instance, Verizon needs to retain more dividends in order to acquire newer assets, start a new project, buy back shares, and purchase even more acquisitions. For example, Verizon should purchase T-Mobile, AT&T, or some other communications company in order to own the telecommunications space. In addition, by retaining more dividends, Verizon will get an enormous tax break which can be used to attack more investors and shareholders. Furthermore, Verizon will also gain an increased return on their investments and shareholder 's equity which can be used to increase their overall value thus giving them the ability to repay dividends at a later date.…

    • 2012 Words
    • 9 Pages
    Great Essays
  • Decent Essays

    | | | | 41) Dividends are not paid on | A. nonparticipating preferred stock. | | B. Dividends are paid on all of these. | | C. noncumulative preferred stock. | | D. treasury common stock.…

    • 3301 Words
    • 14 Pages
    Decent Essays
  • Brilliant Essays

    and Lintner, J. (1962) Bird-In-Hand Theory. Cited in: Brigham, E.F. and Daves, P.R. (2007) Intermediate Financial Management. 9th edn. U.S:…

    • 3632 Words
    • 15 Pages
    Brilliant Essays
  • Superior Essays

    1. Leading / Lagging Indicators: Leading Indicators is a classification of indicators which are used to predict future economic trend. In contrast, lagging indicators respond to events and are used to confirm a pattern that has developed. A few of the impacts of these indicators on businesses are highlighted below: 1.…

    • 1513 Words
    • 7 Pages
    Superior Essays
  • Great Essays

    The cost of equity for Mallard is 12.4% as per below calculation. The valuation of Mallard shares is $20.6675 million which is lower than the offer price $22 million. Dividend valuation model relies on strict assumptions, including a constant expected dividend growth rate. The growth rate estimation is very subjective because the dividend growth rate is based on historical data over 5 years. Mallard’s management decided to dispose of the company, hence it might declare more dividend in recent years in order to boost up the dividend growth.…

    • 2912 Words
    • 12 Pages
    Great Essays
  • Improved Essays

    We can take advantage of erratic behaviour of Mr. Market using the concept of tactical asset allocation strategy. Tactical asset allocation decisions are based on the behaviour of the market. Following this strategy we will book profits when markets have appreciated and invest more when stock prices have fallen. Price Earnings (P/E) ratio is generally used to take tactical decision on asset allocation. Higher P/E ratio indicates that the stock market is expensive and there is probable market correction round the corner.…

    • 1032 Words
    • 5 Pages
    Improved Essays
  • Decent Essays

    The Intelligent Investor

    • 780 Words
    • 4 Pages

    Research is necessary to be successful in the stock market. By supporting its position, this paper will provide a survey of scholarship on the subject. In 2006, The Intelligent Investor by Benjamin Graham with commentary by Jason Zweig discussed Peter Lynch’s rule: “No one should ever invest in a company, no matter how great its products or how crowded its parking lot, without studying its financial statements and business value” (Zweig 126). This rule contradicted the belief that one can pick stocks without doing any homework.…

    • 780 Words
    • 4 Pages
    Decent Essays