Question

this is for my advanced corporate finance class.. please give a broad and clear explanation on this question.

Describe the clientele effectin demand for dividend paying stocks. What sort of investors should wish to hold dividend paying stocks and which should not? Why? Describe Modigliani & Miller's irrelevance Propositionon dividend policy. Provide a plausible argument to explain why this proposition should hold. Explain the possible advantages and disadvantages of paying out funds through dividends or share repurchase. Describe the evolution of payout policy through dividends and share repurchase over the last 3 years (since 1982). What are the causes of these general changes in policy.

please do not give me a handwritten answer, its difficult to read

Answer 1

The clientele effect is an investment theory thag hypothesizes the investors in a security will have a direct impact on the price of the security when a change in policy affects their investment objective.

The theory is based on the notion certain investors are attracted to a company's stock because of their policies. These individuals will buy or sell the security if a change in policy takes place that is aligned with or no longer aligns with the individual investment objectives.

The clientele effect says that dividend policyis irrelevant because investors that prefer high payouts will invest in firms that have high payouts and investors that prefer low payouts will invest in firms with low payouts. If a firm chmages its payout policy, it will not affect the stock value, it will just end up with a different set of investors. This is true as long as the market for dividend policy is in equilibrium.

The irrelevance theorem was developed by Merton Miller and Franco Modigliani. It is a theory of corporate capital structure that posits financial leverage doesnot affect the value of a company if income tax and distress costs are not present in the business environment.

It illustrates the practical situations where dividends are not relevant to investors. Irrespective of whether a company pays a dividend or not, the investors are capable enough to amke their own cash flows from the stocks depending on their need for the cash. Thus theory firmly states that the dividend policy of a company has no influenc3 on the investment decisions of the investors.

The theory believes that dividends are irrelevant by the arbitrage arguement. By this logic, the dividends distribution to shareholders is offset by the external financing. Due to the distribution of dividends, the price of the stock decrease s and will nullify the gain made by the investors because of the dividends. The theory also implies that the cost of debt is equal to the cost of equity as the cost of capital is not affected by the leverage.

Assumptions of the model:

1. Perfect capital markets

2. No taxes.

3.Fixed investment policy

4. No risk of uncertainty

A cash dividend is money paid to stockholders, normally out of the corporation's current earnings or accumulated profits. Not all companies pay a dividend. Usually the board of directors determines if a dividend is desirable for their particular companh based upon various financial and economic factors.

Dividends are commonly paid in the form of cash distribution s to the shareholders on a monthly, quarterly or yearly basis. All dividends are taxable as income to the recepients.

Payout policy tthrough dividends and share repurchase is concerned with financial policies regarding paying cash dividend in the present or paying an increased dividend at a later stage