For many years economists and financial experts have argued about the „dividend puzzle“, i.e. about the impact of dividends on stock prices. Describe this puzzle, explain why it appears so intractable, and state what might be done to bring us all closer to an acceptable solution.
THE DIVIDEND PUZZLE
For many years economists and financial experts have argued about the „dividend puzzle“, i.e. about the impact of dividends on stock prices. Describe this puzzle, explain why it appears so intractable, and state what might be done to bring us all closer to an acceptable solution.
The dividend policy of a company is one of its major long term decisions. Although a lot of companies pay parts of their earnings out in form of dividends, many arguments against these cash payments to the investors exist. Especially the fact that dividends are often subject to higher taxation than for example share repurchases, give a yet unsolved puzzle to many financial specialists.
This paper wants to give some insight in the different existing theories and models behind the dividend puzzle, and tries to give the reader an understanding of the main problems.
Modigliani and Miller (MM, 1961) showed in a fundamental model, that under the assumptions of a perfect and complete capital market and a constant investment strategy of a company, the dividend payout policy is completely irrelevant to the wealth of investors. The elements of such a market are the absence of taxes, symmetrical information, complete contracting possibilities, no transaction costs and a complete market. The model proofed that an investor is able to undo a companies dividend policy and adjust it to personal cash desires by selling or reinvesting the companies stocks. Although this is a good basis for an ongoing consideration of this topic, the assumption of a perfect market doesn’t really hold in reality.
Before we try to consider the impact of different market imperfections we should have a look at situations there dividends should be avoided anyway, at least theoretically: when there is not enough cash for dividend payments available. (1) a positive NPV (net present value) project should never be given up to increase dividend payments. (2) never issue stocks just to finance a dividend payment, because direct cost of issuance and personal taxes (adverse tax consequence) will reduce wealth of the stockholders. Although financial economists generally agree about this, company managers sometimes have to make a compromise in reality for there own reasons (i.e. to keep dividend payments constant over years).
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- Quote paper
- DI (FH) Mag. Reinhard Windisch (Author), 2005, The dividend puzzle, Munich, GRIN Verlag, https://www.grin.com/document/86704