Chapter 19 -- Dividend Policy and Investment Decisions
 Miller and Modigliani (M&M) Hypothesis
 Assumptions
 no taxes, transaction costs, or brokerage fees
 no flotation cost
 information is free and available to all
 Conclusion: in a perfect capital market dividend policy does not matter

 Brokerage fees must be paid by the shareholders to reinvest dividends
 There could be an information cost to reinvesting dividends
 Some companies use dividend reinvestment plans to eliminate brokerage fees
 The presence of transaction costs decreases the desire for the company to pay dividends

 Floatation cost is the cost of issuing new debt or equity to replace money paid out in the form of dividends
 The presence of flotation cost would decrease the desire to pay dividends

 Dividends proceeds are taxed at ordinary income or special dividend rates
 Share repurchases are taxed at capital gains rates
 Clientele effects may mitigate some taxes for a small clientele

 High tax paying individuals may not hold stock in dividend-paying companies
 Some pension plans have dividend requirements for the stock to be held in their portfolios
 Taken together portfolio considerations are probably not very influential on dividend policy

 Paying dividends may signal expectations of increasing future cash flows
 Actions speak louder than words
 False signals are too costly
 Information signaling has a significant influence on dividend policy

 An increase in dividends increases the agency cost of debt
 Dividends take money out of the company that would otherwise serve as a safety margin for creditors
 Dividends decrease the agency cost of equity
 Dividends take money out of the company that might otherwise serve as a safety margin for managers or be consumed frivolously by managers

 Investment opportunities
 Institutional restrictions
 Legal requirements
 Restrictive covenants
 Income rules
 Improperly accumulation earnings tax
 Cash flow
 Management interest


 Control
 Takeover defense
 Management attitudes toward risk
 Management growth preference

 Constant dollar policy
 Constant pay-out ratio policy
 Constant dollar plus extras
 Residual policy
 Constant dollar with increases each year
 For those companies paying dividend this appears to be the most popular -- easier for the analyst to project

 You receive, for example, 5 additional shares for each hundred shares you held
 If you owned 1% of the company before, you own 1% after the stock dividend
 Stock dividends simply divide ownership into smaller pieces
 May signal future dividend plans

 Alternative to dividends for distributing money to shareholders
 Taxed at capital gains rate
 Voluntary, not mandatory
 Positive signal
 May not create expectation