Question

Discuss whether dividends are relevant to investors, in other words, does it make a difference to an investor if a company pays out dividends or keeps the money and the value of the stock goes up by the same amount. Would it matter to you if you were an investor? Would it matter to the company?

Answer 1

Recall MM hypothesis. In the absence of taxes, dividend and dividend policy is irrelevant. Hence, dividend doesn't create any additional value for the shareholders. Reserves and surplus (accumulation of company's earnings) belong to the shareholders. Dividends are paid out from that reserves and surplus which anyways belong to the shareholders. Hence, if there are no taxes (corporate or individual), then it really doesn't matter whether dividends are paid or not. Shareholders wealth is the total reserves and surplus whether partly or fully or not at all available in the form of dividends. A dividend payout reduces the value of the stock by the same amount. Hence, stock value prior to dividend = Dividend + sock price after dividend. Hence, dividend is irrelevant from the perspective of the shareholders.

However, in the presence of corporate taxes and dividend distribution taxes, dividend distribution leads to a leakage through dividend distribution tax. Hence, dividends then become relevant.

• Dividends bring liquidity. Hence, investor may prefer a dividend.
• Receipt of dividend allows you to reinvest that into a better opportunity, if any. Hence, dividend can actually allow you to earn a better return overall, through reinvestment.
• Equity investments are not guaranteed investments. There is no return guaranteed. Even the principal investment is not safe. A dividend ensures the investor gets some money (in a way return of his capital).
• Dividend payout signals positivity and optimism. Share price may rise due to this.

If I am an investor it will not matter to me.

It does matter to the company, as dividends payout leads to leakage through dividend distribution tax.