The Irrelevance Theory

When a company makes profit, its board of directors may choose to either allocate a portion of its net profits to its shareholders through what is known as dividend distribution or else they may choose to retain such profits and increase firm’s cash flow. Dividends may be distributed in the form of shares, cash payments or through property or other fixed assets. However, it is necessary to note that such dividend payments are neither fixed amounts nor guaranteed as this would depend upon the company’s current position.

When it comes to making a decision on whether to distribute such dividends or not, two factors need to be taken into consideration: The dividend payment may either be seen as a form of maximising wealth or else it may be seen

In fact, shareholders will be indifferent as to whether their earnings were made through issuance of dividend or simply through capital growth. It also puts forward the idea that when comparing two firms within the same industry, if one pays dividends and the other does not, each firm should still have the same value as the other.

There are a number of factors that need to be taken into consideration when concerned with the Irrelevance Theory. The fact that it assumes a perfect market, allows a number of opposing theories to be put forward which go against the M&M assumption. Therefore, when such assumptions do not hold, the dividend policy becomes relevant. The schools of thought relating to such dividend relevance theories include those ideas put forward by Walter, Gordon and Lintner as well as a few other opposing theories which have also been

Although Miller and Modigliani assume a perfect market with no information asymmetry, in the real world it is evident that many companies withhold a great amount of information which may be of use to potential investors. Firms may use ‘window- dressing’ techniques to deviate their share prices and make them seem more appealing than they actually are. Therefore, share price may not always be a valid indicator to measure a firm’s value. As a result to this, investors began to use dividend pay-outs as a signalling tool as to whether a firm is financially sound or not and whether they should invest in it or not. Increase in dividend pay-out, strongly predicts positive future prospects and therefore can be used as an indicator within an imperfect