The Irrelevance of the MM Dividend Irrelevance Theorem

28 Pages Posted: 14 Mar 2005  

Harry DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: January 2005

Abstract

Contrary to Miller and Modigliani (1961), payout policy is not irrelevant and investment policy is not the sole determinant of value, even in frictionless markets. MM ask "Do companies with generous distribution policies consistently sell at a premium above those with niggardly payouts?" But MM's analysis does not address this question because the joint effect of their assumptions is to mandate 100% free cash flow payout in every period, thereby rendering "niggardly payouts" infeasible and forcing distributions to a global optimum. Irrelevance obtains, but in an economically vacuous sense because the firm's opportunity set is artificially constrained to payout policies that fully distribute free cash flow. When MM's assumptions are relaxed to allow retention, payout policy matters in exactly the same sense that investment policy does. Moreover, (i) the standard Fisherian model is empirically refutable, predicting that firms will make large payouts in present value terms, (ii) only when payout policy is optimized will the present value of distributions equal the PV of project cash flows, (iii) the NPV rule for investments is not sufficient to ensure value maximization, rather an analogous rule for payout policy is also necessary, and (iv) Fischer Black's (1976) "dividend puzzle" is a non-puzzle because it is rooted in the mistaken idea that MM's irrelevance theorem applies to payout/retention decisions, which it does not.

Keywords: Dividend policy, payout policy, mm theorems, dividend puzzle

JEL Classification: G35, G32, K22, M41, D90, H24

Suggested Citation

DeAngelo, Harry and DeAngelo, Linda, The Irrelevance of the MM Dividend Irrelevance Theorem (January 2005). Available at SSRN: https://ssrn.com/abstract=680855 or http://dx.doi.org/10.2139/ssrn.680855

Harry DeAngelo (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-6541 (Phone)
213-740-6650 (Fax)

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-3868 (Phone)
213-740-6650 (Fax)

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