[T1W8] - DIVIDEND POLICY
DETERMINING DIVIDEND POLICY
Deciding how much of the company’s earnings should be paid out to shareholders and how much should
be retained within the company.
Consider if the dividend policy (payout policy) that a company adopts makes a difference to a firm’s
market value.
● If the dividend policy makes a difference to a firm’s market value, what is an optimal dividend
policy?
● If not, why does the company bother to pay dividends?
DIVIDEND POLICY IN THE REAL WORLD
Lintner 1956 - Determining Optimal Coporate Dividend Policy
Lintner carried out an empirical observation on firms in the 1950s on how important dividend policy was
and how much payouts were. Key findings:
● Firms should adopt a long-term stable dividend payout policy (avoid cutting dividend at all costs)
● Increase dividend after an increase in earnings, but only by sustainable amount (to avoid having
to cut dividends)
In the Real World
High-growth firms tend to adopt a low payout policy while slower-growth firms adopted a higher payout
policy.
Most companies appear to increase dividend payout ratio gradually in the direction of some target ratio
● If target ratio is set too high and earnings fluctuate, then frequent recourse to external financing
may be necessary in order to maintain dividend, thereby incurring unnecessary issue costs
● The greater the variability of earnings, the lower should be the target payout ratio, and the lower
the speed of adjustment towards that target.
MILLER & MODIGLIANI (1961)
Uses the concept of the ‘perfect’ world where there are no transaction costs, no taxes and no information
asymmetry.
The 1961 papers suggests that earnings, C depend on
investments, I. Therefore according to the diagram, where I
is fixed, C is fixed in order to increase D, firm must
increase K by exactly the same amount.
DETERMINING DIVIDEND POLICY
Deciding how much of the company’s earnings should be paid out to shareholders and how much should
be retained within the company.
Consider if the dividend policy (payout policy) that a company adopts makes a difference to a firm’s
market value.
● If the dividend policy makes a difference to a firm’s market value, what is an optimal dividend
policy?
● If not, why does the company bother to pay dividends?
DIVIDEND POLICY IN THE REAL WORLD
Lintner 1956 - Determining Optimal Coporate Dividend Policy
Lintner carried out an empirical observation on firms in the 1950s on how important dividend policy was
and how much payouts were. Key findings:
● Firms should adopt a long-term stable dividend payout policy (avoid cutting dividend at all costs)
● Increase dividend after an increase in earnings, but only by sustainable amount (to avoid having
to cut dividends)
In the Real World
High-growth firms tend to adopt a low payout policy while slower-growth firms adopted a higher payout
policy.
Most companies appear to increase dividend payout ratio gradually in the direction of some target ratio
● If target ratio is set too high and earnings fluctuate, then frequent recourse to external financing
may be necessary in order to maintain dividend, thereby incurring unnecessary issue costs
● The greater the variability of earnings, the lower should be the target payout ratio, and the lower
the speed of adjustment towards that target.
MILLER & MODIGLIANI (1961)
Uses the concept of the ‘perfect’ world where there are no transaction costs, no taxes and no information
asymmetry.
The 1961 papers suggests that earnings, C depend on
investments, I. Therefore according to the diagram, where I
is fixed, C is fixed in order to increase D, firm must
increase K by exactly the same amount.
