what is dividend irrelevance theory 
dividend irrelevance theory posits that dividends don t have any effect on a company s stock price a dividend is typically a cash payment made from a company s profits to its shareholders as a reward for investing in the company dividend irrelevance theory goes on to state that dividends can hurt a company s ability to be competitive in the long term since the money would be better off reinvested in the company to generate earnings although there are companies that have likely opted to pay dividends instead of boosting their earnings there are many critics of dividend irrelevance theory who believe that dividends help a company s stock price to rise understanding dividend irrelevance theorydividend irrelevance theory suggests that a company s payment of dividends should have little to no impact on the stock price if this theory holds true it would mean that dividends do not add value to a company s stock price the premise of the theory is that a company s ability to earn a profit and grow its business not dividend payments determines a company s market value and drives the stock price those who believe in dividend irrelevance theory argue that dividends don t offer any added benefit to investors and in some cases argue that dividend payments can hurt the company s financial health 1dividend irrelevance theory was developed by economists merton miller and franco modigliani in 1961 the duo are also responsible for the modigliani miller theorem both were awarded the nobel prize in economics dividends and stock pricedividend irrelevance theory holds that the markets perform efficiently so that any dividend payout will lead to a decline in the stock price by the amount of the dividend in other words if the stock price was 10 and a few days later the company paid a dividend of 1 the stock would fall to 9 per share as a result holding the stock for the dividend achieves no gain since the stock price adjusts lower for the same amount of the payout 1however stocks that pay dividends like many established companies called blue chip stocks often increase in price by the amount of the dividend as the book closure date approaches although the stock can decline once the dividend has been paid many dividend seeking investors hold these stocks for the consistent dividends that they offer which creates an underlying level of demand also the stock price of a company is driven by more than the company s dividend policy analysts conduct valuation exercises to determine a stock s intrinsic value these often incorporate factors such as dividends and a company s financial healthdividend irrelevance theory suggests that companies can hurt their financial well being by issuing dividends which is not an unprecedented occurrence dividends could hurt a company if the company is taking on debt in the form of issuing bonds to investors or borrowing from a bank s credit facility to make their cash dividend payments let s say that a company has made acquisitions in the past that have resulted in a significant amount of debt on its balance sheet the debt servicing costs or interest payments can be detrimental also excessive debt can prevent companies from accessing more credit when they need it most if the company has a hard line stance of always paying dividends proponents of dividend irrelevance theory would argue that the company is hurting itself over several years all of those dividend payouts could have gone to paying down debt less debt might lead to more favorable credit terms on the remaining outstanding debt allowing the company to reduce its debt servicing costs 3also debt and dividend payments might prevent the company from making an acquisition that might help increase earnings in the long term of course it s difficult to pinpoint whether dividend payments are to blame for a company s underperformance mismanaging its debt poor execution by management and outside factors such as slow economic growth could all add to a company s difficulties however companies that don t pay dividends have more cash on hand to make acquisitions invest in assets and pay down debt if a company is not investing in its business through capital expenditures capex there could be a decline in the company s valuation as earnings and competitiveness erode over time capital expenditures are large investments that companies make for their long term financial health and can include purchases of buildings technology equipment and acquisitions investors that buy dividend paying stocks need to evaluate whether a management team is effectively balancing the payout of dividends and investing in its future dividend irrelevance theory and portfolio strategiesdespite dividend irrelevance theory many investors focus on dividends when managing their portfolios for example a current income strategy seeks to identify investments that pay above average distributions i e dividends and interest payments while relatively risk averse overall current income strategies can be included in a range of allocation decisions across a gradient of risk strategies focused on income are usually appropriate for retirees or risk averse investors these income seeking investors buy stocks in established companies that have a track record of consistently paying dividends and a low risk of missing a dividend payment blue chip companies generally pay steady dividends these are multinational firms that have been in operation for a number of years including coca cola pepsico and walgreens boots alliance these companies are dominant leaders in their respective industries and have built highly reputable brands surviving multiple downturns in the economy also dividends can help with portfolio strategies centered around the preservation of capital if a portfolio suffers a loss from a decline in the stock market the gains from dividends can help offset those losses preserving an investor s hard earned savings 