Dividend Irrelevance Theory

The Dividend Irrelevance Theory (Franco Modigliani and Merton Miller, 1961) is one of the fundamental models that every investor should know.

The theory states that it does not matter whether an organization distributes dividends or not; the dividend distribution policy does not affect the stock price.

Mathematically, this holds true (if we disregard taxes). When an organization reinvests funds wisely instead of distributing dividends, the investor’s wealth increases and is reflected in the stock price. Conversely, if the organization cannot find positive NPV projects and distributes dividends, the investor can invest the received income elsewhere.

In practice, young and rapidly growing organizations do not distribute dividends because they manage to make highly profitable investments. Mature and stable organizations, on the other hand, do distribute dividends…