Relevance or Irrelevance of Retention for Dividend Policy Irrelevance

International Review of Applied Financial Issues and Economics, Vol. 2, No. 2, pp. 232-247, 2010

13 Pages Posted: 7 Nov 2007 Last revised: 14 Dec 2010

See all articles by Carlo Alberto Magni

Carlo Alberto Magni

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

Date Written: November 4, 2007

Abstract

In an interesting recent paper, DeAngelo and DeAngelo (2006) highlight that Miller and Modigliani’s (1961) proof of dividend irrelevance is based on the assumption that the amount of dividends distributed to shareholders is equal or greater than the free cash flow generated by the fixed investment policy. They claim that, if retention is allowed, dividend policy is not irrelevant. This paper shows that the dividend irrelevance proposition holds even in case of retention. The key assumption has not to do with retention but with the NPV of the extra funds (either retained or raised): if NPV is zero, dividend irrelevance applies. Yet, the dichotomy retention/no-retention is useful, because if agency problems are present, managers tend to retain funds and invest them in negative-NPV projects, and therefore the zero-NPV assumption must be removed, so that dividend irrelevance does not apply any more.

Keywords: Dividend policy, irrelevance, retention, zero-NPV, epistemology, agency theory

JEL Classification: B41, G30, G31, G35

Suggested Citation

Magni, Carlo Alberto, Relevance or Irrelevance of Retention for Dividend Policy Irrelevance (November 4, 2007). International Review of Applied Financial Issues and Economics, Vol. 2, No. 2, pp. 232-247, 2010, Available at SSRN: https://ssrn.com/abstract=1027401

Carlo Alberto Magni (Contact Author)

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

Italy

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