Ch.7 - Equity sources ad dividend policy

Question 1

What was Modigliani and Miller position on irrelevancy of dividend policy?

Answer 1

Consistency of dividend stream was irrelevant.
=> as long as dividend cut is being used to fund a positive NPV project, then the increased dividends in the future would be more than enough to compensate for the lower dividend today
=> they suggested that where investors required certain level of income, then if dividends were cut, they could simply sell a few shares, thus manufacturing dividends

Question 2

What is the impact of dividend policy in the real world?

Answer 2

Dividend signalling = with listed companies, a reduction in dividend can convey ‘bad news’ to shareholders

The clientele effect = in practice tax differences and transaction costs mean that investors are not indifferent between dividends and capital growth (manufacturing dividends by selling shares)

Question 3

What are alternatives for dividends for the company?

Answer 3

1. share buybacks
2. scrip (stock) dividends (scrip issue = bonus issue, not the same as scrip dividend) = choice of taking their dividends in the form of new shares rather than cash
   
   • benefits to shareholder: increased shareholding without broker’s commissions or stamp duty on purchase
   • benefit to company: does not have to find cash to pay out dividend and can save tax (in certain circumstances)