Gordon's Theory Of Dividend Policy

When a company decides to pay dividends, it has to be careful on how much it will be given to the shareholders. It is of no use to pay shareholders dividends

Since the emergence of the so-called irrelevance theorem by Miller and Modigliani (1961), many corporations are puzzled about why some firms pay dividends while others do not. They were the first to study the effect of dividend policy on the market value of firms by assuming that there are no market imperfections. Miller and Modigliani (1961) proposed that divided policy chosen by a firm has no significant relationship in as far as the market valuation of the firm is concerned. They went further to explain that; the shareholders wealth remains unchanged irrespective of how the firm distributes it income because the firms’ value is rather determined by their investment policies and the earning power of its assets. They further stated that the opportunity to earn abnormal returns in the market does not exist, that is, owners are entitled to the normal market returns adjusted for risk.

Dividend Policy | -Pay out dividend to shareholders in profitable period | -100% plowback to reinvest in the business |

After considering the operational improvements forecasted, we project Robertson’s free cash flows and compute the terminal value using the Gordon Growth Method; the implied share price is analyzed further in accordance to growth rate and discount rate.

Some of the results that empirical studies of the dividend theories have produced are that all factors other than distribution level should be held constant, that is the sample companies should differ only in their distribution levels. Second each firms cost of equity should be measured with a high degree of accuracy. Unfortunately we cannot find a set of publicly owned firms that differ only in their distribution levels nor can they obtain their cost of equity. That’s why nobody has been able to identify a relationship between the distribution level and the cost of equity or firm value. Although none of the empirical test are perfect, recent evidence shows that firms with higher dividend payouts also have a higher required returns. This tends to support the tax effect hypothesis, even though the size of the required return is too high to be explained by taxes. All of this can affect what you tell a manager because they make the decision to expropriate shareholders wealth and

The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.

Based on the financing needs, as above dividends would be additional stretch on company finances

They published a paper on; “dividend policy, growth and valuation of shares”. Their major point of argument was on the importance of dividend payout policy on a firm’s valuation by investors. Their argument was made based on several assumptions thus the investor would be indifferent on those firm that pay dividends and those that don’t. In their 1961 paper they said that in determining the firm’s future performance, then its capital structure is irrelevant. Modgliani and miller hold the view that in the eyes of investor gains from capital investments dividends are seen as equivalent to returns. Therefore it is from the firm’s earning that the firm’s value can be derived. This is dependent on the firm’s policy which guides it n the areas to invest in and the industry’s Lucrative. Industry lucrative is public information and therefore investors will only require knowing the investment policy in order to make investment decisions. They argue that an investor in a firm that is paying dividends and is not in need of money at the time dividend is issued will reinvestment the money in stock. In a firm that does not pay dividend an investor in need of money will only sell part of stock thus acquiring the amount of money that is in need

According to this theory, dividend policy does not affect stock prices or the cost of capital of the company. Therefore, the dividend policy becomes irrelevant. This theory developed by Miller and Modigliani in year 1961, which states that the value of the company is only determined by the expected earnings and risk of the company. Value of company only depends on profit that comes from expected assets instead of dividing profit into dividend and retained earnings. These theories assume that the dividend policy does not bring any impact to the value of the company. Thus, the increase or decrease in dividends by the company will not affect the value of the

Firms are normally open to choose the level they want to pay a dividend to shareholders common stock, although factors such as legal requirements, debt agreements and availability of cash resources require some limitations on this result. Therefore, it is not uprising that the observed literature has recorded systematic variation in dividend behavior throughout the company, country, time and type of dividends. Variations among the registered firm, for example, Fama and French (2001) .They bring evidence to recommend that U.S. firms pay dividends tend to be huge and profitable, while non-payers are typically miniature, less profitable but high chance investment. Variation nationwide include La Porta, Lopez - de - silanes, Shleifer

For the reason that Porsche did not increase the number of shares in the last years and the dividend payout did not increase constantly, we concluded that Porsche is not using the stability dividend policy. Nevertheless, since Porsche 's dividend strategy is a rising one, we assumed that they are using a mixture of the residual and the stability policy, namely the hybrid strategy. Admittedly, we have to say that their dividends did not increase depending on the level of net income as the next

Starting off with the Gordon Growth Model was developed by Professor Myron Gordon of the University of Toronto. It explains that if any investor is aware of the dividends handed out in a year by any company, and at what rate that dividend will grow, the investor is able to determine the actual value of the stock, which describes what the investor should pay at most for the selected stock issued by the company. (Ozyasar, 2015)

The payment of dividends and the issue of shares in return for capital investment are important aspects of company law. As such, there are certain requirements that must be met in order for both shares and dividends to be lawfully issued. These requirements are located within the company’s articles and statute. The Company’s articles “operate as contract between the company and its members” and outline the requirements that the directors must follow in order for a transaction to be lawful.

Structure  15.1  Introduction  15.2  Traditional Approach  15.3  Dividend Relevance Model  15.3.1  15.3.2  Walter Model  Gordon’s Dividend Capitalization Model

There are many theoretical and empirical results describing the decisions companies make in this area. At the same time, however, there is no generally accepted model describing payout policy. Moreover, empirical findings are often contradictory or difficult to interpret in light of the theory. In their seminal paper, Miller and Modigliani (1961) showed that under certain assumptions dividends are irrelevant; all that matters is the firm’s investment opportunities. Miller and Modigliani considered the case of perfect capital markets (no transaction costs or tax differentials, no pricing power for any of the participants, no information asymmetries or costs), rational behaviour (more wealth being preferred to less, indifference between cash payments and share value increases) and perfect certainty (future investments and profits are given). In real life, however, people seem to care about dividends. Lintner.s (1956) classical study on dividend policy suggests that dividends represent the primary and active decision variable in most situations. Lintner suggests a model of partial adjustment to a given payout rate.