Thursday, January 20, 2005
Are dividends a good thing?
David, over at Seeking Alpha, argues that dividend paying stocks are a mistake. He's essentially expressing an implication of the Modigliani Miller theorem: if the market rate of return equals the rate of return on reinvested capital, then it does not matter what the dividend payout ratio is. Of course, as he points out, buybacks are a more tax efficient way for firms to return cash to shareholders. Moreover, Glenn Hubbard and others have long argued that most firms can generate a much higher rate of return on reinvested capital than the market rate but can not do so due to asymmetric information in credit markets. This suggests that dividends may not only be bad for shareholders, but they may be bad for economic growth as well.
On the other hand, dividends can be a form of signaling by which honest firms can signal to the market that they care about shareholders by returning money to them today instead of taking the money and using it to purchase $6000 shower curtains (i.e. a bit like going to university to prove that you are bright, not because university makes you more productive). I think this helps explain the current fad for dividend paying stocks (especially in light of Enron and WorldCom).
On the other hand, dividends can be a form of signaling by which honest firms can signal to the market that they care about shareholders by returning money to them today instead of taking the money and using it to purchase $6000 shower curtains (i.e. a bit like going to university to prove that you are bright, not because university makes you more productive). I think this helps explain the current fad for dividend paying stocks (especially in light of Enron and WorldCom).
# posted by Stockcoach @ 10:23 PM 
