Abstract
The impacts of an enterprise’s dividend policy on share prices wield considerable significance to the investors, economists, and corporate officials. The economists try to appraise and understand the operations of the capital markets, the corporate officials institute the guidelines, while the investors plan the portfolios. Throughout the process, several queries arise: Do the firms with substantial distribution policies sell their premiums over those with negligible payouts? If yes, under what circumstances? Is there a standard series of ratios or payouts that can maximize the share prices? The three questions have been the focus of various studies, but the researchers have yet to obtain a consensus. The reason for the inconclusive outcomes is the absence literature. The lack of information makes investigators unable to frame precise results for different hypotheses. There is thus need to fill in the gap that exists in the theoretical valuation of shares.
Literature Review
The writers pursue the study with the aims of alleviating the obstacles that prevent efficient empirical testing. The paper assesses previous literature to find out the gaps that are present and constructs theoretical guidelines to supplement the loopholes. The authors divide their analysis into five sections to make it easier to obtain and dissect relevant information concerning valuation from the scholarly works of various professional such as Hunt Pearson, Fisher, and Benjamin Graham. In the first part, they examine the effects of the variations in dividend policies in the existing share prices in an ideal finance system with capital markets, perfect certainty, and rational behavior (Miller and Modigliani, 1961). Within the analytical domain, the writers proceed to section two and three to evaluate corresponding issues that introduce misunderstandings in the dividend policies.
The second part entails a debate that has been looming in economics regarding whether investors really exhaust their shares. Section three is grounded on the relationships between dividend growth, an increase in profits, and price. Once the fundamentals are formulated, the article proceeds to the fourth section to see the extent of discrepancies within the dividend policy due to the certainty assumption. The last part looks at the impacts of the dividend policy in imperfect markets. The writers support their work by using formulas that act as guidelines for retrieving the information for the five sections (Miller and Modigliani, 1961).
Data/Sample
The article is entirely theoretical with the exceptions of formulas that relate variables and support hypotheses. Hence, there is no sample or index. The discussion is only classified in the five sections stated above to evaluate the implications of dividend policy on an imperfect or perfect market (Miller and Modigliani, 1961).
Authors’ Hypotheses
The writers target the looming gap in empirical reviews over recent years to obtain a consensus in the theory of valuation. They provide a new meaning to basic assumptions that are utilized in economic discussions such as perfect certainty, rational behavior, and perfect markets. The article also creates a relation between the dividend stream and that of firm earnings. The correlation is brought out by specializing in a particular case where investment opportunities are evident so that the speculators can obtain a constant growth rate of profits (Miller and Modigliani, 1961).
Authors’ Findings/Conclusions
The hypotheses delegated above leads to the following outcomes. First, the authors bring out new definitions and characteristics of financial assumptions. In the capital markets that are perfect, no seller or buyer has the potential of controlling the prices. Both of them are equal and do not impose any costs to access data concerning share characteristics and prices. No transaction expenses, transfer taxes, and brokerage fees are incurred in the buying of securities. Rational behavior highlights that the objective of the investor in to acquire more wealth; hence he or she will be indifferent as to whether the profits comes in the form of increased value of their shares or cash payments (Black & Scholes, 1974).
Perfect certainty entails the complete assurance from both parties: the investor and the company. Due to the assurance, there is no need to differentiate between bonds and stocks in the analysis of the sources of income. The economists can thus proceed as if there was one financial instrument. Based on the three assumptions, all the shares are governed by one fundamental guideline: the value of the share must mirror returns and will be the same throughout a span of time (Black & Scholes, 1974). The implications of the principle above affect the dividend policy in that it creates a sharper focus regarding its three routes: individual share prices, the present and future market value, and current distribution. The authors utilized various formulas to value the share prices. After that, they let go of the presumption of perfect markets and focus on the imperfect ones. The imperfection makes an investor choose certain profit-making avenues over the others (Miller and Modigliani, 1961). The individual bias or preferences introduce costs of obtaining financial information and brokerage fees. The imperfections result in an advantage in capital gains rather than dividends from taxable personal incomes.
Implications
The paper fills in the gap and answers the queries that have been bothering the financial analysts and economists for several years. They receive sufficient knowledge to frame precise assessments to understand hypotheses involving dividend policy and its effects as well as the valuation of shares and the growth of firms. The authors outline the implications of dividend policy in both imperfect and perfect markets on the valuation and growth of shares. Investors are required to make rational decisions that will result in long-term and considerable profits (Miller and Modigliani, 1961). Hence, this paper is also applicable to them as a guide to make suitable investment choices based on the performance and dividend policy in a firm. It is now easier to develop a relationship between payouts and premiums to prevent irrationality. The investors may be naïve when they first penetrate the financial markets. Therefore, the companies take advantage of their limited information and institute imperfect situations. Their lack of information puts them at a disadvantage, and they may have to bear extensive brokerage fees just to get their needs fulfilled. However, with time, the speculators will acquire adequate experience from the financial market or by reading articles like this one to understand the operations of the dividend policy and valuation of shares from a better standpoint.
References
Black, F., & Scholes, M. (1974). The effects of dividend yield and dividend policy on common stock prices and returns. Journal of financial economics, 1(1), 1-22.
Miller M. and Modigliani F. (1961). Dividend Policy, Growth, and the Valuation of Shares. The Journal of Business, Vol. 34, No. 4.