Potential Dividends and Actual Cash Flows: A Critical Analysis

Velez-Pareja, Ignacio; Magni, Carlo Alberto

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: 26 Jun 2012

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Carlo Alberto Magni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering)

Date Written: May 8, 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 Classification: M21, M41, G12, G31, G35

Suggested Citation: Suggested Citation

Velez-Pareja, Ignacio and Magni, Carlo Alberto, Potential Dividends and Actual Cash Flows: A Critical Analysis (May 8, 2009). Estudios Gerenciales. Journal of Management and Economics of Iberoamerica, Vol. 25, No. 113, pp. 123-150, October-December 2009, Available at SSRN: https://ssrn.com/abstract=1095068