dividend policy

The dividend policy is focused on deciding which part of the profit in the company stays in the company itself and how much is distributed to shareholders as dividends.

The dividend policy is included in the financing decisions of the company, since any money paid in dividends to be financed some way (new borrowing, a new capital increase, issue of new shares ...)

  The goal is to find that policy that makes maximum market value of the shares, but how dividends affect the value of the shares? 

Then let's look at two positions of the dividend policy:

-Theory of Litner and Gordon:

Gordon and Lintner dividend policy affects the value of the shares of the company. Give to the dividend an essential role in determining the value of the company, as investors prefer real returns and at the present time.

The rate of performance of shares (Ke) increases with decreasing rate of profit sharing because from the point of view of investors, dividend payments are safer than those that come via capital gains, from the point of view shareholder, the value of a euro dividend is greater than the one of capital gains as the yield on safer than the growth rate of these dividends.

-Theory of Modigliani and Miller:

Modigliani and Miller (MM) claim that in a perfect capital market, the dividend policy of the company is irrelevant in terms of their effect on the value of their shares, because this is determined by the power of generator  benefits and type of risk, this will depend on the investment policy of the company and not by how many benefits are distributed or retained.

Modigliani and Miller showed that if the company paid higher dividends, should issue more new shares to meet the payment, the value of the company delivered to the new  shareholders is identical to the dividends paid of the old shareholders. Now, all this will be true as long as some basic assumptions:

• -The individual investors and companies can borrow at the same interest rate.

• The cost of debt (K) is independent of the level of debt and the current yield is considered to have no risk.

• -All information is available at no cost for all investors. In addition, investors have homogeneous expectations about benefits and risks.

• There are no taxes or transaction costs.

• -The companies are grouped into classes of equivalent risk.

If this is true, it can be shown that an increase in the dividend per share results in an equal reduction in the share price, leaving unchanged shareholder wealth. So the current shareholder wealth not change even if the dividend policy is altered. Therefore the value of the company depends only on its investment policy.


dividend policy

dividend policy