The Dividend Irrelevance Theory argues that a company`s dividend policy is completely irrelevant. The theory was proposed in 1961 by Merton Miller and Franco Modigliani (MM). In particular, Mm argues that the dividend policy has no impact on the share price or its capital cost. Modigliani – Miller`s theory goes even further and illustrates practical situations where dividends are not relevant to investors. Whether or not a company pays a dividend, investors are able to draw their own cash flow from the shares, based on their cash requirements. If the investor needs more money than the dividend he received, he can still sell some of his investments to make up the difference. Similarly, if an investor does not have up-to-date cash requirements, the dividend received can reinvest in the stock at any time. Thus, Modigliani-Miller`s theory finds that a company`s dividend policy has no influence on investor investment decisions. Modigliani – Miller Theory was proposed by Franco Modigliani and Merton Miller in 1961.
They pioneered the assumption that dividends and capital gains were equivalent when an investor was considering returns. The only thing that influences a company`s valuation is the direct result of the company`s investment policy and future prospects. According to this theory, once the investment policy is known to the investor, he will not need an additional contribution on the company`s dividend history. The investment decision therefore depends on the investment policy of the company and not on the dividend policy. Note that the proposal of miller and Modiglianis on irrelevant dividends applies to the entire payment policy of the company. These include share repurchases and other means in which the company distributes the company`s net profit to shareholders. We discussed the proposal proposed by MM regarding the insignificance of the dividend. It starts from a perfect world where there are no taxes, transaction costs and shares that are infinitely divisible. Modigliani and Miller, famous for their theories on the structure of capital, have advanced the theory of the relevance of dividends, which we will examine below more closely. If you pass the CFA exam or a professional financial exam, this theory is one of the essential achievements of learning.
Below, we analyze the theory of how investors treat dividend cash flow and whether the theory is true in real life. MM say that if an investor receives a dividend that is more than expected, then he can reinvest in the company`s shares with excess cash flow. If the expected dividend is too small, then it can sell part of its shares and replicate the same cash flow it would receive if the dividend was what it expected. In both cases, investors are not relevant to the company`s dividend policy because they are able to generate their own cash flow. There are no taxes. Alternatively, dividends and capital income are taxed at the same rate. On this side, we discuss why Miller and Modigliani say that dividend policy does not matter. We are also debating the concept of home dividends, which is actually the main argument that reinforces the proposal of irrelevant dividend mms.