A NOTE ON DIVIDEND IRRELEVANCE AND THE GORDON VALUATION MODEL

THE CONTRIBUTIONS of Modigliani and Miller to the theory of corporate finance are justly celebrated:' indeed many authorities would date the development of modern analytical financial theory to their path-breaking 1958 article. Yet, while the points of disagreement between the theory of capital structure expressed in their earlier articles and the traditional theory have been narrowed down to differing empirical assumptions, the same cannot be said of their later article on dividend policy: "Dividend Policy, Growth, and the Valuation of Shares."2 Nine years after the publication of this latter article there continue to co-exist among financial theorists two opposing views on the importance of dividend policy in perfect markets. The first and older view, originally articulated by Myron Gordon,3 and still commanding widespread assent, can be paraphrased by the statement that even in perfect capital markets,4 the existence of uncertainty about the future suffices to make the price of a share dependent upon the dividend policy which is followed: and that in particular, the more generous is the dividend policy, the higher will be the price of the share. Miller and Modigliani on the other hand, have argued that once the investment policy of a firm is given, the price of its shares is invariant with respect to the size of the dividend paid.' The issue between these opposing views cannot be settled by resort to experience, for the fundamental reason that the above hypotheses relate to the effects of dividend policy in perfect capital markets, whereas of course actual securities markets suffer from several imperfections, the most important of which, from the point of view of dividend policy, are the existence of transactions costs and of differential taxes on income from dividends and capital gains." Despite this, there is a paucity of articles on the theoretical differences