Financial management

Topics: Stock market, Capital structure, Dividend Pages: 4 (754 words) Published: October 30, 2013
Question

The dividend discount model tells us that the value of a firm is equal to the present value of its expected dividend payments.

Some firms have never paid dividends and have no intention of doing so.

Does this mean that these firms are worth nothing? Discuss with reference to academic research and theory.

Answer
719 words

Two schools about dividend policy: relevant dividend theory and irrelevant dividend theory

The dividend discount model tells us the value of a firm is equal to the value of its expected dividend payments. The dividend discount model provides a means of developing an explicit expected return for the stock market. Elaborations on the simple dividend discount model provide an important tool for comparing relative values across a sample of individual stocks.

V is the value of the stock.
Dt is the expected dividend payment at the year t.
K is the discount rate.

Dividend policy has always been a baffling problem of financial management. In theoretical circles there are two schools about dividend policy: relevant dividend view and irrelevant dividend view.

Relevant dividend view: Farrar, Salwyn and Gordon are representatives of this theory. Their theory is that company's dividend distribution has an impact on the value of the company. Dividend payment is not dispensable, but very necessary. It is an important strategy of a company. If the company’s choice of the dividend payment policy on the stock market changes , the company's capital structure and corporate value will be affected, as well as the realization of shareholders' wealth. Dividend policy is closely related to the value of the company.

The different branches of relevance dividend view are only from a certain angle to explain the dividend policy and stock price. However, in the imperfect capital market, there are various factors influence the company’s dividend policy and stock price,such as income tax, financing costs, market efficiency, etc....

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Lease, R. C., John, K., Kalay, A., Loewenstein, U., & Sarig, O. H. (2008). Dividend Policy:: Its Impact on Firm Value. OUP Catalogue.
Bar-Yosef, S., & Kolodny, R. (1976). Dividend policy and capital market theory. The Review of Economics and Statistics, 58(2), 181-190.
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Hakansson, N. H. (1982). To pay or not to pay dividend. The Journal of Finance, 37(2), 415-428.
Friend, I., & Puckett, M. (1964). Dividends and stock prices. The American Economic Review, 54(5), 656-682.
Bhattacharyya, N. (2007). Dividend policy: a review. Managerial Finance,33(1), 4-13.
Magni, C. A. (2007). Relevance or irrelevance of retention for dividend policy irrelevance. Available at SSRN 1027401.
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