Pay-out or NOT? (Dividend Policy)

After an investment decision have been made, the firm probably is starting to concern with the dividend policy in order to retain and satisfy the investor. In order words, firms should consider the amount of earnings to be retained and the amount to be pay out to compensate investor for delaying their spending by investing in the firm.

A controversial theory according to  Modigliani and Miller (1961) claimed that the dividend is irrelevance proposition to shares value, it is meaning that investors are indifferent with the capital gains and dividend pay out. M&M assume that in the perfect market it is fine for firm not to pay out divided when it is positive NPV project on hands. In the perfect market condition such as no taxes, no transaction cost and etc etc, investor indifferent with holdings the present value of $100 and the future value of $105 one year later with the annual inflation of 5%. 

I could not agree more with Modigliano and Miller (1961) theory of dividend irrelevancy if only the current market is in the perfect market situation because it is definitely not any different with holdings the FV which have the value with the PV now! However, we have to accepted to true that the perfect market is only seem to be appear in the M&M theory. We as a investors are just having a little or no information of company practice and  insider information, it is not easy to completely trust the firm judgement or valuation on the investment project. 

This is similar to the Linter and Gordon (1962) "Bird-in-the-hand" theory which argue that dividends are preferable to capital gains because of uncertainty. Perhaps the future is just way  unpredictable and from the empirical study past history doesn't be the best indicator to predict the future movement. Furthermore, one of the significant issue should be questioned is what kinds of markets are we currently investing at. The market is full of emotion, selfishness, cost, etc etc, therefore, investors rather get the dividend pay out now instead of later to minimize the risk. In addition, majority of investors have lost the trust buy putting their hard earn money with the firm due to the various scandal have been reveal to the market. Thus, it create a more preferable dividends gains to capital gains.

On the other hands, by having read thought the clientele effects, pay out or not or the dividend policy of the firm should also be concern on the type of shareholders. It is utterly crucial for company to understand who is their investors, by doing that it helps the firm to working on dividend pattern which is either more to a income investor or a capital gains investors. 

Different investor might be have different preference on the dividend pay out policy, some rather the firm invest on more project to gain higher return, some prefer a steady income pay out.

Leave me comment tell me what type of shareholder you are and why? :)