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The dividend decision

M&M’s dividend irrelevancy theory

1.1 M&M’s (Modigliani and Miller’s) assumptions

 There exists a perfect capital market.

 There are no transaction costs.

 There are no taxes, or dividends and capital gains are taxed in the same way.

 The entity’s operating cash flows are the same no matter which dividend policy
is adopted.

1.2 Statement of theory

The pattern of dividend pay outs should be irrelevant.

As long as companies continue to invest in positive NPV projects, the
wealth of the shareholders should increase whether or not the
company makes a dividend payment in the year.

Therefore, M&M suggested that entities should focus on investment policy rather
than dividend policy, and that if investors required income, they could sell shares to
‘manufacture’ dividends.

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