Payout Policy Pedagogy: What Matters and Why

Abstract:     
This paper argues that we should abandon MM (1961) irrelevance as the foundation for teaching payout policy, and instead emphasize the need to distribute the full value generated by investment policy ("full payout"). Because MM's assumptions restrict payouts to an optimum, their irrelevance theorem does not provide the appropriate prescription for managerial behavior. A simple example clarifies why the correct prescription is "full payout," and why both payout and investment policy matter even absent agency costs (DeAngelo and DeAngelo (2006)). A simple life-cycle generalization explains the main stylized facts about the payout policies of U.S. and European firms.

Keywords: Payout policy, dividends, capital budgeting, corporate finance

JEL Classifications: G35, G31

Working Paper Series