Potential Dividends and Actual Cash Flows: A Critical Analysis
Estudios Gerenciales. Journal of Management and Economics of Iberoamerica, Vol. 25, No. 113, pp. 123-150, October-December 2009
28 Pages Posted: 19 Feb 2008 Last revised: 9 Oct 2014
Date Written: May 8, 2009
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 Classification: M21, M41, G12, G31, G35
Suggested Citation: Suggested Citation