Dividend Policy and Firm Value: Examining Walter's, Gordon & MM Models

This essay provides an analysis of dividend policy, focusing on the relevance and irrelevance theories and examining three key models: Walter's Model, the Gordon Growth Model, and the Modigliani-Miller (MM) Model. It explains how each model approaches the valuation of a firm based on its dividend policy, highlighting the relationship between internal rate of return and cost of capital in Walter's Model, the importance of dividend growth rate in the Gordon Growth Model, and the emphasis on earning power and risk in the MM Model. The essay concludes that dividend policy is relevant and significant for directing corporations on how and when to pay dividends to investors, ultimately aiming to improve investment returns and provide a stable income stream.

DIVIDEND
DECISION
Student details:

INTRODUCTION
 The dividend refers to the sum of money paid on
the regular basis by a corporation out of profits to
the stakeholders of company.
 The dividend policy refers to the decision related to
finance which refers to a proportion of earnings of
company to be paid to the stakeholders of an entity.

 The company takes decision on the proportion
of revenue, which is required to be given to
the stakeholders as the dividend or to be
ploughed again in the company.
 According to the dividend models, it is
believed by some practitioners that the
stakeholders do not have concern regarding
the dividend policy of company and may
realize cash by the trading of cash in case of
requirement.

 On the other hand, it is believed by
other that dividend is relevant and has
the bearing on company’s stake prices
(Bremberger, et. al, 2016).
 The models can be explained from
following diagram-

RELEVANCE THEORY
 In the Relevance theory, the selection of
dividend policy influences value of firm.
 As per this policy, the changes in dividend
payout ratio would be adopted by the
changes in company’s market value.
 In a case where dividend is relevant, it is
required to be best payout ratio.

IRRELEVANCE THEORY
 The irrelevance theory of dividend is a
theory that investor does not require to
concern themselves with the
dividend policy of company as investor
has choice to sell the part of portfolio
of equities in case of requirement of cash
(Subramaniam and Wasiuzzaman, 2018).

WALTER’S MODEL
 Walter’s Model is given by Professor
James Walter. According to this model,
the dividend is relevant and has a
bearing on stock price of firm.
 Walter’s Model states that there is clear
relation between internal rate of return
(r) or ROI and the cost of capital (K).
 The selection of proper dividend policy
influences whole firm’s value. The
effectiveness of dividend policy can be
stated by the relation between cost and
return.

WALTER MODEL’S
VALUATION FORMULA

GORDON GROWTH MO
DEL
 The Gordon Growth Model is named as
dividend discount model.
The Gordon Growth Model refers to the
method for the determination of
intrinsic value of stock, exclusive of
present market condition.
 The Gordon Growth model equates the
value to a current value of future
dividend of stock.

 There are two circumstances to make this
Model efficient.
 Firstly, an entity must distribute dividend.
 Next, the dividend growth rate (g) should not
exceed required rate of return (k) of company.
In a case where dividend growth rate is more
than required rate of return, the result will not
be positive.
 Moreover, stocks may not have negative
value.

GORDON GROWTH
MODEL’S VALUATION

MODIGLIANI-MILLER
MODEL
 It is stated by the Modigliani-Miller
model that the company’s market value
is measured by using the powers of
earning and the risk of the fundamental.
 As per this model, it is easy to finance
the investments or distribute the
dividend.

MM MODEL’S VALUATION
FORMULA

CONCLUSION
 As per the above analysis, it can be concluded
that the dividend policy is relevant and
significant.
 Dividends render the stable income stream for
the improvement of investment return.
 The dividend policy serves the aim of directing
the corporation on how to pay dividend and
when to pay dividend to the investor.

REFERENCES
 Subramaniam, V. and Wasiuzzaman, S.
(2018) Corporate diversification and
dividend policy: empirical evidence from
Malaysia. Journal of Management and
Governance, pp.1-24.
 Bremberger, F., Cambini, C., Gugler, K.
and Rondi, L. (2016) Dividend policy in
regulated network industries: Evidence
from the EU. Economic Inquiry, 54(1),
pp.408-432.