Dividend irrelevancy theory

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In financial theory, dividend payments and policies should be irrelevant when financial markets are efficient.

This is because amounts retained - or distributed - by the company would in theory earn the same future rate of return for the investors.

Moreover, investors who require cash could sell part of their holdings.

While investors who don't require cash could use any dividend distributions to buy more shares in the company.

But in practice decisions about dividend levels are important because of:

  1. Their informational content. This informational content is known as signalling.
  2. The potential to move closer to, or away from, a firm's optimal capital structure.
  3. Possibly, clientele effects, including taxes on investors.

See also