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Potential Dividends and Actual Cash Flows: Theoretical and Empirical Reasons for Using 'Actual' and Dismissing 'Potential'
Ignacio Velez-Pareja Universidad Tecnologica de Bolivar Department of Finance and International Business - Instituto de Estudios para el Desarrollo (IDE) Carlo Alberto Magni University of Modena and Reggio Emilia - Department of Economics Estudios Gerenciales. Journal of Management and Economics of Iberoamerica, Vol. 25, No. 113, pp. 123-150, October-December 2009 Abstract: Practitioners and most academics in valuation include changes in liquid assets (potential dividends) in the cash flows. This widespread and wrong practice is inconsistent with basic finance theory. We present economic, theoretical, and empirical arguments to support the thesis. Economic arguments underline that only flows of cash should be considered for valuation; theoretical arguments show how potential dividends lead to contradiction and to arbitrage losses. Empirical arguments, from recent studies, suggest that investors discount potential dividends with high discount rates, which means that changes in liquid assets are not value drivers. Hence, when valuing cash flows, we should consider only actual payments.
Keywords: flow to equity, potential dividends, equity value JEL Classifications: M21, M41, G12, G31, G35 Accepted Paper SeriesDate posted: February 19, 2008 ; Last revised: February 16, 2010Suggested CitationContact Information
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