Dividend Theory Flashcards
What are the 4 dividend policy theories?
1) M&M Irrelevance
2) Traditional Theory
3) Signalling
4) Clientele
What is M&M irrelevance theory?
The pattern of dividends over time is irrelevant in determining shareholder wealth
If the source of equity finance is irrelevant then the dividend policy is also irrelevant
Firms should undertake all positive NPV projects if they want to maximise shareholder wealth
Dividend can be pad after all positive NPV projects have been undertaken.
What is traditional theory?
A dividend payment involves the sacrifice of retained earnings that could be used to undertake positive NPV projects that increase wealth through a higher share value
Shareholders will prefer £1 of dividend income now over £1 of capital gain in the future
More value will be put on a firm to pay dividends
What is signalling theory?
Investors don’t have perfect information. Rely on signals
Payment of a dividend is a positive signal.
Firms should adopt a stable and rising dividend pay-out to maintain investors confidence
What is Clientele Theory?
Investors will be attracted to firms by their dividend policy
High dividend payout companies attract those who prefer current income
Low dividend payout companies attract those who prefer future gains
