Dividend Irrelevance theory

“the wealth of the shareholders is not affected by dividend policy.” Suggested by ​Miller and Modigliani,
(1961)

Researches that supported dividend irrelevance theory

● Brennan, (1971) supported the irrelevance theory of Miller and Modigliani and concluded that any
rejection of this theory must be based on the denying of the principle of symmetric market
rationality and the assumption of independence of irrelevant information. He suggested that for
rejection of latter assumption, one of these following conditions must exist:
○ Investors do not behave rationally
○ Stock price must be subordinate of past events and expected future prospect
● Black and Scholes, (1974) reported findings that were consistent with dividend irrelevance
hypothesis.
● Hakansson (1982) supported the irrelevance theory of Miller and Modigliani and claimed that
dividends, whether informative or not, is irrelevant to firm's value when investors have
homogeneous belief and time additive utility and market is fully efficient

Researches that challenged dividend irrelevance theory

● Ball, Brown, Finn, and Officer, (1979) after a study in Australian stock market from 1960 to 1969
claimed to have found significant relationship between return of stock and dividend yield in the
next year after dividend payment. However, their findings failed to support the irrelevance
dividend theory.
● Baker, Farrelly, and Edelman, (1985) did a survey among the 603 Chief Financial Officers (CFOs)
of 562 companies which were listed on the New York Stock Exchange (NYSE). The results of
their survey showed that respondents strongly agreed that stock prices will be affected by
dividend policy.
● Baker and Powell (1999) conducted a survey among 603 Chief Financial Officers of US
companies which were listed on the NYSE. They reported that majority of respondents (90
percent) agreed that dividend policy has impact on value of firm and affect firm's Stock Price
volatility too.

Aspects of Dividend relevance theory

firms which pay dividend to their shareholders, are considered positively and bear a good image in their
minds. If companies don’t pay dividend then it increases the uncertainty in the eyes of investors and the
payment of dividend increases the share price of firms.

Signalling hypothesis - information content of dividend

investor is always risk-avoider and desires to obtain dividend instead of capital gains in future. So
dividend payments have a great impact on market price of share. While making investment decisions,
investors monitor the firm dividend policy and compare dividends with capital gains. This theory
advocates that a bird in hand is usually better than the bird in bush. Here, bird in the hand is considered
as dividend, whereas bird in bush is assumed to be capital gain. Thus, it is better to receive an income
right now instead of waiting for future gain with some degree of risk involved in it. On the other hand,
dividends are not as much risky as capital gains.

Bird in hand theory - Uncertainty of future dividends

“investors may prefer present dividend instead of future capital gains because the future situation is
uncertain even if in perfect capital market ” ​Gordon, (1956 and 1962)

agency cost

clientele effects

suggests that due to the changes in dividend policies, firm’s share price also reacts to changes in
dividend policies. Accordingly, investor takes decision on the basis of firm’s dividend polices. Whenever
firms change their dividend policies, investors make their investment decisions accordingly

Impact of Dividend Policy on Stock Price Volatility: Evidence from Sri Lanka
By DEWASIRI NARAYANAGE JAYANTHA

https://www.tandfonline.com/doi/full/10.1080/23311975.2017.1408208?af=R