QUESTION 2:

EMPIRICAL STUDIES SHOW THAT AN INCREASE IN THE PRICE PER SHARE OF COMMON STOCK COMMENSURATES WITH AN INCREASE IN DIVIDENDS? A) WHY DONT ALL FIRMS JUST INCREASE THEIR DIVIDENDS THEN? B) CAN THIS BE TAKEN AS EVIDENCE THAT THE VALUE OF THE FIRM IS IN FACT AFFECTED BY DIVIDEND POLICY? DISCUSS THIS FULLY WITHIN THE CONTEXT OF PERFECT AND IMPERFECT MARKETS, DRAWING UPON EXTANT EMPIRICAL FINDINGS.

Case Study 3

Why dont all firms just increase their dividends then?

Some analysts feel that dividend policy is irrelevant, because investors can create their own home made dividends by buying or selling shares. Instead of distributing money to the shareholders, the firms can reinvest that money back into the company to foster further growth

Why dont all firms just increase their dividends then?

Companies may want to keep reserves of cash in case of financial instability It is claimed that little to no dividend payout is more favourable for investors as dividends are taxed at a higher rate than capital gains

Can this be taken as evidence that the value of the firm is in fact affected by dividend policy? Discuss this fully within the context of perfect and imperfect markets, drawing upon extant empirical findings.

The MM policy says that dividend policy is irrelevant in a perfect market Value is only created by investing in productive assets not by financial structuring Although this theory is based on unrealistic perfect market assumptions (No taxes, agency costs and transaction costs) States that investors can make their own dividends by selling shares if they want more dividends or buying shares if they want less

Imperfect Market

An increase in dividends that leads to an increase in price per share, is just the markets revising the new information available about the companies confidence in regards to future earnings Example An earning increase is much more credible when accompanied by a dividend increase. Dividend increase is seen as a signal that the firm expects future increases in the cash flow

Imperfect Market

Clientele Effect The theory that a companys stock price will move according to the demands and goals of investors in reaction to a tax, dividend or other policy change affecting the company. The clientele effect assumes that investors are attracted to different company policies, and that when a companys policy changes, investors will adjust their stock holdings when a companys policy changes. As a result of this adjustment, the stock price and market equity will move