M & M Theory: The Theories Of Zero Dividend Policy
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Zero dividend policy This policy refers to the company that does not pay dividend to its shareholders (MBA Skool, n.d.). Some companies believe that using company profit to grow the company is more valuable. Even though the company does not pay dividend, but the growth of the company may increase its share price so that shareholders may gain capital appreciate on it. Warren Buffett's Berkshire Hathaway is the best example of the company that does not pay dividend (Trendshare.org, 2017). However, the performance of the company must be good and is in the growing industry in order to build shareholders’ confidence to invest in company shares as shareholders may lose their capital upon company wounding up.
Dividend Policy Theories and Market Value…show more content… 100% earnings pay to its shareholder.
There will also have some criticisms on M & M theory. The criticisms are:- Existence of taxes and transaction costs of the markets. Firms and individuals have a different borrowing interest rate. In the real world, firms will not distribute the all the earnings as dividends. Residual Dividend Policy This theory assumes that investors basically want to earn a higher return on their investment (Pika, Neale & Linsley, 2012). Therefore, when the firm has profitable investment opportunities that give a higher rate of return than the cost of retained earnings, the investors would prefer the firm retain the earnings for those investments. On the other hand, no profitable investment opportunities, the investors would prefer to receive the dividends rather than retain those earnings. The primary focus of the firm that using this residual dividend policy is on the investment decision, therefore, any dividend decision made based on this theory will not affect the shareholders’ wealth or share price of the company (Chawla, n.d). The dividends paid will fluctuate every year, but shareholders will be compensated with the capital gain in the…show more content… Walter model According to Prof. James E. Walter, dividend policies always affect the value of the firm. He argues that in the long run, share prices reflect only the present value of expected dividends (The institute of chartered Accountants of India, n.d). Walter’s theory show that dividend payout is related to the firm’s internal rate of return (r) and cost of capital (k), which affect the firm’s value (Borad, n.d).
Relationship between r and k Increase in Dividend Payout Decrease in Dividend Payout r > k (growth firm) Firm’s value decreases Firm’s value