dividend irrelevance

(noun)

Theory that a firm's dividend policy is not relevant because stockholders are ultimately indifferent between receiving returns from dividends or capital gain.

Related Terms

Examples of dividend irrelevance in the following topics:

  • Dividend Irrelevance Theory

    • Dividend irrelevance follows from this capital structure irrelevance.
    • Under these frictionless perfect capital market assumptions, dividend irrelevance follows from the Modigliani-Miller theorem.
    • If dividends are too small, a stockholder can simply choose to sell some portion of his stock.
    • However, the importance of a firm's dividend decision is still contested, with a number of theories arguing for dividend relevance.
    • Merton Miller, one of the co-authors of the capital irrelevance theory which implied dividend irrelevance.

  • Residual Dividend Model

    • The Residual Dividend Model first uses earnings to finance new projects, then distributes the remainder as dividends.
    • The Residual Dividend Model is a method a company uses to determine the dividend it will pay to its shareholders.
    • The Residual Dividend Model is an outgrowth of The Modigliani and Miller Theory that posits that dividends are irrelevant to investors.
    • It goes on to say that dividend policy does not determine market value of a stock.
    • The Residual Model dividend policy is a passive one and, in theory, does not influence market price because the same wealth is created for the investor regardless of the dividend.

  • Investor Preferences

    • The significance of investors' dividend preferences is a contested topic in finance that has serious implications for dividend policy.
    • Assuming dividend relevance, coming up with a dividend policy is challenging for the directors and financial manager of a company because different investors have different views on present cash dividends and future capital gains.
    • Investor preferences are first split between choosing dividend payments now, or future capital gains in lieu of dividends.
    • Stable versus irregular dividends, and 3.
    • In contrast, others (see Dividend Irrelevance Theory) argue that the investors are indifferent between dividend payments and the future capital gains.

  • Value of a Low Dividend

    • Furthermore, capital gains are taxed at lower rates than dividends.
    • However, under dividend irrelevance theory, the actual value of a dividend is inconsequential to investors.
    • The conflicting theories on dividend policy complicate interpretations of low dividends in real life.
    • If a stock has a low dividend yield, this implies that the stock's market price is considerably higher than the dividend payments a shareholder gets from owning the stock.
    • Conversely, a low dividend yield can be considered evidence that the firm is experiencing rapid growth or that future dividends might be higher.

  • Discounted Dividend vs. Corporate Valuation

    • The dividend discount model values a firm at the discounted sum of all of its future dividends, and does not factor in income or assets.
    • The dividend discount model (DDM) is a way of valuing a company based on the theory that a stock is worth the discounted sum of all of its future dividend payments.
    • There is no reason to use a calculation of next year's dividend using the current dividend and the growth rate, when management commonly disclose the future year's dividend, and websites post it.
    • b) If the stock does not currently pay a dividend, like many growth stocks, more general versions of the discounted dividend model must be used to value the stock.
    • One common technique is to assume that the Miller-Modigliani hypothesis of dividend irrelevance is true and, therefore, replace the stocks's dividend D with E earnings per share.

  • Impact of Dividend Policy on Clientele

    • Change in a firm's dividend policy may cause loss of old clientele and gain of new clientele, based on their different dividend preferences.
    • Suppose Firm A had been in a growth stage and did not offer dividends to its shareholders, but their policy changed to paying low cash dividends.
    • These investors are known as dividend clientele.
    • On the other hand, the firm may attract a new clientele group if its new dividend policy appeals to the group's dividend preferences.
    • This theory is related to the dividend irrelevance theory presented by Modigliani and Miller, which states that, under particular assumption, an investor's required return and the value of the firm are unrelated to the firm's dividend policy.

  • ROE and Potential Limitations

    • Return on equity measures the rate of return on the ownership interest of a business and is irrelevant if earnings are not reinvested or distributed.
    • Return on equity is equal to net income, after preferred stock dividends but before common stock dividends, divided by total shareholder equity and excluding preferred shares.
    • The true benefit of a high return on equity comes from a company's earnings being reinvested into the business or distributed as a dividend.
    • In fact, return on equity is presumably irrelevant if earnings are not reinvested or distributed.

  • Leverage Models

    • Annual interest is $6,000 and preferred dividends are $2,000 per year.
    • The Modigliani–Miller theorem is also often called the Capital Structure Irrelevance Principle.
    • We discount the amount of preferred dividends payed by the tax deductions brought about by those dividends and subtract the result and the cost of interest on debt from EBIT.

  • Dividend Yield Ratio

    • The dividend-price ratio is a company's annual dividend payments divided by market capitalization, or dividend per share divided by the price per share.
    • The dividend yield or the dividend-price ratio of a share is the company's total annual dividend payments divided by its market capitalization, or the dividend per share, divided by the price per share.
    • There is no guarantee that future dividends will match past dividends or even be paid at all.
    • Others try to estimate the next year's dividend and use it to derive a prospective dividend yield.
    • Current dividend yield = Most recent Full-Year Dividend / Current Share Price

  • Defining Dividends

    • A dividend is allocated as a fixed amount per share.
    • When it is time to make dividend payments, corporations always pay preferred stock owners first, and then common stock dividends are allocated after all preferred dividends are paid in full.
    • Dividends may be allocated in different forms of payment, outlined below:Cash dividends are the most common.
    • In-dividend date is the last day, which is one trading day before the ex-dividend date, where the stock is said to be cum dividend ('with [including] dividend').
    • After this date the stock becomes ex-dividend.