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Dividend Policy

 Self-Paced Overview

Dividends

Dividends are payments made to stockholders from a firm's earnings, whether those earnings were generated in the current period or in previous periods.

Dividends may affect capital structure.

  • Retaining earnings increases common equity relative to debt.
  • Financing with retained earnings is cheaper than issuing new common equity.

Dividend Policy and Stock Value

There are various theories that try to explain the relationship of a firm's dividend policy and common stock value.

Dividend Irrelevance Theory

This theory purports that a firm's dividend policy has no effect on either its value or its cost of capital. Investors value dividends and capital gains equally.

Optimal Dividend Policy

Proponents believe that there is a dividend policy that strikes a balance between current dividends and future growth that maximizes the firm's stock price.

Dividend Relevance Theory

The value of a firm is affected by its dividend policy. The optimal dividend policy is the one that maximizes the firm's value.

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