MODIGLIANI AND MILLER

Modigliani and Miller's Dividend Irrelevance Theory (M&M)



Modigliani and Miller's Dividend Irrelevance Theory (M&M)

Introduction

In 1961, Modigliani and Miller proved that the dividend policy of a company has no effect on the value of the shareholders. The taxes and transaction costs are not taken into account and complete balanced information about the distribution of uncertain future cash flows of the company. Modigliani and Miller solved a paradigm shift from the prevailing opinion that increase in dividends maximize the wealth of shareholders (Modigliani and Miller, 1961, 261). Modigliani and Miller (M&M) showed that in an efficient capital market, the dividend policy of the company is irrelevant to its effect on shareholder value, since this is determined by its power generator benefits and by type of risk, that is, dependent on the investment policy the company and not by how many benefits are distributed or retained. M&M showed that if the company paid a dividend greater, it should issue more new shares to meet the payment, with the value of the company delivered to the new shareholders identical to the dividends paid to existing shareholders.

Discussion

The basis for the argument that dividends do not matter is simply that shares of companies that pay higher dividends will receive a lower cost, and total shareholder return remains unchanged. This is due to the fact that firm's value is determined by investment such as factories, equipment and other assets. If a firm that pays higher dividends, can bring new shares, raise capital and make exactly the same investments, it would have made, if it had not paid dividends, its total cost would have been independent of its policy of paying dividends. In the end, the assets that it owns, the income that it generates are the same regardless of whether it pays high dividends or not (Brealey and Myers, 1998, 287).

In a market, where there are costs of issuing shares to the company, it is more expensive to raise money through the issuance of shares than getting through retained earnings. The effect of issuance costs is to eliminate indifference between issuing shares to fund dividend payments and domestic financing. For this reason, dividend payments will only occur if profits are not used entirely for investment purposes, that is, only when there is "residual earnings" after setting the investment policy of the company (McMenamin, 1999, 33). So this policy is called the residual theory of dividends, which could break down in the following points:

1.Keep constant the ratio of debt for future investment projects.

2.Acceptance of a proposed investment only if its NPV is positive.

3.Finance the disbursement of new projects from common stock, primarily using internal financing as it runs through the issuance of new titles.

4.If some toner without applying any domestic financing after allocating investment projects will be distributed via dividends. Otherwise there will be no dividend payments.

This theory tends to consider that dividends are not important, that is, the value of the company has nothing to do with its dividend policy. The same estimated Miller and Modigliani (M & ...