Lecture 14

Question 1

What is Miller & Modigliani (1961) Irrelevance Result?

Answer 1

• Under certain assumptions, value of firm with fixed investment policy is unaffected by payout policy choice
• Alternatively, if firm value is affected by payout policy then MM (1961) assumptions are vioalted

Question 2

What are Miller & Modigliani (1961) assumptions?

Answer 2

• Taxes and Costs
• Agency Costs
• Asymmetric Information
• Other behavioural reasons

Question 3

What is the Tax Clienteles Theory of Dividends?

Answer 3

• Some investors prefer high dividends:
  “Income-oriented” investors or investors with low marginal tax rates prefer high dividends, and they allocate portfolio towards high-dividend paying stocks
• Other investors prefer low dividends:
  “Growth-oriented” investors or investors with high marginal tax rates prefer low dividends and they allocate portfolio towards low-dividend stocks
• Static tax clientele model:
  Firms with different payout policies attract different groups of investors
  In equilibrium, there is no incentive for any firm to change its policy
  So firm value is independent of payout policy

Question 4

What is the Catering Theory of Dividends?

Answer 4

• Baker and Wurgler (2004) proposed that:
  Decision to pay dividends is driven by investor demand
• Managers cater to investors by
  paying more dividends when investors put a stock price premium for dividend-paying firms
  Stopping /reducing dividends when dividend-paying firms trade at a discount