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9.3 Irrelevance Of Dividend Policy

The other school of thought on dividend policy and valuation argues that what a firm pays as dividend to shareholders is irrelevant and the shareholders are indifferent about receiving current dividends receiving capital in future. The advocates of this school of thought argue that the dividend policy has no effect on the market price of a share. The shareholders do not differentiate between the present dividend or future capital gains. They are basically interested in higher returns earned either by the firm by investing profits in profitable investment opportunity or earned by them by making investment of dividend income.

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The conclusion that dividends are not relevant is based on two pre conditions:

  • That investment and financing decisions are already being made and that these decisions will not be altered by the amount of dividend payments.
  • That the perfect capital market is there in which an investor can buy and sell the shares without any transaction cost and that the companies can issue shares without any flotation cost.

Two theories have been discussed below to focus the irrelevance of dividend policy for valuation of the firm though it is well accepted that like the capital structure irrelevance proposition, the dividend irrelevance argument has its roots in the Modigliani-Miller Analysis.

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