Irrelevanz der Ausschüttungspolitik?

Directory

1. Introduction

2. Scale A - Irrelevance
2.1 Key assumptions of the model
2.1.1 Perfect capital markets
2.1.2 Rationality
2.1.3 Perfect certainty
2.2 Miller/Modigliani share valuation

3. Scale B - Relevance
3.1 Gordon and Walter
3.2 De Angelo/De Angelo’s full payout

4. Consequences of retention

5. A scale in balance - Conclusion

Bibliography

“Do companies with generous distribution policies consistently sell at a premium over those

with niggardly payouts? ” Merton Miller and Franco Modigliani, 1961¹

1. Introduction

The excerpt above, from the introduction of Merton Miller and Franco Modigliani's article “Dividend Policy, Growth, and the Valuation of Shares ” shows very perspicuously what this expose will be about: the influence of distributions on the value of a company.

In 1961, Miller and Modigliani (abbreviated MM) contrived that the distribution policy of a company is, under certain circumstances, not able to influence its share value,² i.e. that the dividend policy is irrelevant. As long as a company distributes the full present value of its cash flow, it is not relevant how or in which period it does this in detail.³

Linda and Harry DeAngelo (D&D) on the other hand found that Miller and Modigliani were wrong.⁴ They say that the model of MM is unnecessary restrictive. In such a way that it even produces false and warped results. After relaxing some assumptions of MMs model, they get a contrary result. In their opinion payout policy is not irrelevant. They say that when retention is allowed it is very well important and relevant which dividend policy a company chooses.⁵ Both points of view got a certain amount of support in the aftermath of their publishing. Prominent authors supporting MM were for example Joseph Stiglitz and Mark Rubinstein,⁶ while Myron Gordon and James Walter argued against it.⁷ But which is the right position? Is it afterall possible to answer this with certainty?

Probably not. Maybe it will last years to get a definite answer; if there will ever be one. None­theless this term paper will try to get some clarity onto that matter. Therefore the expose will start in chapter 2 with a review of Miller and Modigliani’s proof of irrelevancy. After this, in chapter 3 there will be a presentation of the contrasting thesis, most recently emphasized by DeAngelo and DeAngelo, who relax the critical assumption of no retention. In chapter 4 there will be a discussion of the consequences for the market participants if retention is allowed, brought forward alongside with its consequences for payout relevancy.

This paper will conclude by weighing the most important arguments of both sides. As it will not succeed in letting the scale tip, so gives an outlook on possible extensions of the MM valuation model. This will at least show the angles where both points of view gainsay the reality up to now.

2. Scale A - Irrelevance

2.1 Key assumptions of the model

Before reciting Miller and Modigliani’s original proof of dividend irrelevancy, it is important to look at the assumptions of their model. Since some of these assumptions are a point of criticism while trying to test the hypothesis empirically and a starting point for extensions of the model, it is important to explain the three most important ones in a few words.

MM derive their results in a surrounding of perfect capital markets, rational behavior and per­fect certainty:

2.1.1 Perfect capital markets

The most important aspect of perfect capital markets is the lack of transaction costs, broker­age fees or tax differentials, which could persuade an investor to preferring one form of distribution to another, i.e. preferring capital gains to dividends.⁸

Another characteristic of perfect capital markets is full informational efficiency, such that all relevant information are available for all market participants costless.⁹ In addition, no market participant is big enough to influence the current market price.¹⁰

2.1.2 Rationality

As in nearly all economic courses, rationality describes the phenomenon that an individual (with untwisted preferences) has a higher utility by getting more wealth; whatever form this wealth may have. In other words: the investor is indifferent to getting more wealth through dividends, repurchases or capital gain, but he always prefers receiving the highest possible present value.¹¹

2.1.3 Perfect certainty

Perfect certainty, the most obvious contradiction to real world observations concerns the evo­lution of future decisions. While one can only guess how the future will manifest itself in real­ity, it is not necessary to estimate in Miller/Modigliani settings. The values of the variables are not subject to outside influences; they are definite. This results in a fixing of the future investment program scheme and the profits of a company. The upshot of this is that it is not necessary to distinguish between stocks and bonds, which is why from now on only stocks are examined.¹²

2.2 Miller/Modigliani share valuation

Now, after describing the set of the MM world the valuation of a company’s shares will be­gin. While doing it, the influence of payout policy on share value is looked at.

In the MM world, an investor has only two paths through which he can participate in the fi­nancial development of a stock issuing company:

The first way is through dividends which the company might distribute and which increases the stockholders wealth. The other participating line is through an increase in the stock price, which would increase his wealth too, because he always has the option to sell his shares.¹³

These two ways determine the rate of return, a company offers potential investors; in algebra: [Abbildung in dieser Leseprobe nicht enthalten] (f)

Abbildung in dieser Leseprobe nicht enthalten

(1)

Here d. (ŕ ) is the dividend company j pays in period t. Since p (ŕ ) is the price of a company’s share after issuing a dividend in t-1, [p (ŕ +1) - p (ŕ)] is the capital gain of a share.

To get the rate of return the two terms (dividend plus capital gain) are divided by the price paid in period t for a share. This yields equation (1).

This rate of return has to be constant all the time and throughout the market, because other­ wise arbitrageurs would sell their low return shares and buy high revenue shares with the pro­ceeds. This would consistently lower the price of the low return share and heighten the high return price, until the yields are the same and the market is in equilibrium.¹⁴ The resulting constant rate of return is called r (ŕ).

If one rearranges equation (1), multiplies it with the number of shares at the start of period t, p (ŕ) and substitutes a term, it results the following equation:

Abbildung in dieser Leseprobe nicht enthalten

Although in the original paper MM here discuss the possible influences of the variables above on the value of the company (i.e. its stocks), this expose will first finish the algebraic rear­rangements and after that take a look at the effects of the variables on the companies’ value. But first there is a need to introduce a third equation:

Abbildung in dieser Leseprobe nicht enthalten

This equation says, that the money earned by issuing new shares (the left, side) has to be ex­actly as sizably as the difference between the expenditures, consisting of the investment costs I . (t) and the dividend payment D. (t), and the net profit of the company in period t, X.(t).¹⁵ In other words the company distributes at least all cash flows as dividends. Some­times even a sum surmounting CF. (t) .

If one substitutes that expression into equation (2) one gets the final valuation equation:

Abbildung in dieser Leseprobe nicht enthalten

(4)

A reminder: the purpose of this expose is to derive the effect of dividend policy on the value of a company. The instruments to do so are now on hand.

As one can see in equation (4) the value of the company is now determined by four factors:

First, the market rate of return r (t). This rate is constant throughout the market; thus prevents arbitrage and is not vulnerable by dividend policy. The second factor, the investment costs I. (t) are given too, because of the assumption of perfect certainty, which assures that the investment level is fixed and which also fixes the third factor, the net profits X. (t) . ¹⁶

These three variables are obviously independent of payout policy since they are either deter­mined by the market {r(t)} or by the investment policy {Xy. (t)andI. (t)}.

Last is the factor V, (t +1) , the value of the company at period t+1. May payout policy per­ haps be able to influence this variable and via it influence today’s value of the company? No. On account of the following reasons this has to be negated:

[...]

¹ Miller/Modigliani (1961, p.411)

² cp. Miller/Modigliani (1961, p.414)

³ cp. Miller/Modigliani (1961, pp.414-417)

⁴ There were others before DeAngelo/DeAngelo who criticized MM but none of them provided a reasonable proof of their point of view

⁵ cp. DeAngelo/DeAngelo (2006, pp.294-295)

⁶ cp. Stiglitz (1974, pp.851-866) and Rubinstein (1976, pp.1229-1230)

⁷ cp. Gordon (1963, p.264) and Walter (1963, p.290)

⁸ cp. Van Horne/McDonald (1971, p.507)

⁹ cp. Fama (1991, p.1575)

¹⁰ cp. Miller/Modigliani (1961, p.412)

¹¹ cp. Miller/Modigliani (1961, p.412)

¹² cp. Miller/Modigliani (1961, p.412)

¹³ cp. Miller/Modigliani (1961, p.412)

¹⁴ cp. Miller/Modigliani (1961, p.412)

¹⁵ CF . [Abbildung in dieser Leseprobe nicht enthalten] cash flow = net profits minus investment costs = money at the free disposal of managers after all valuable investment projects have been conducted. Cp. DeAngelo/DeAngelo (2006, p.297)

¹⁶ cp. Miller/Modigliani (1961, p.414)