Dividend Policy

Question 1

What is the MM Theory? Why is Dividend Policy Irrelevant?

Answer 1

In perfect capital markets, a firm’s dividend policy has no effect on its value or on shareholders’ wealth.
Firm should never give up positive NPV for an increase in dividends, vice versa.

Question 2

Dividend Increase Value

Answer 2

• Some investors (dividend clientele) prefer dividends for regular income.
  
  • Firms that increase dividends may attract these investors, raising share demand and prices.
  • Signaling theory: Higher dividends may signal strong future prospects, increasing valuation.

Question 3

Dividend Decrease Value

Answer 3

• In the presence of taxes, especially if dividends are taxed more heavily than capital gains, high dividends can reduce firm value.
  
  • Investors may prefer retained earnings or capital gains to minimize tax burden.

Question 4

What is the Clientele Effect?

Answer 4

Different groups of investors (“clienteles”) prefer different dividend policies based on their individual tax situations, income needs, or investment preferences.