Industry Influence on Dividend Policy

* The relationship between dividend policy and firm valuation is a major unresolved issue in corporate finance. Both theoretically and empirically, research evidence proves to be contradictory. The seminal article by Miller and Modigliani [10] showed that dividend policy is irrelevant to investors, provided that each investor is rational and that dividends and capital gains are taxed at the same rate. Yet, dividend policy is an important concern of most financial managers (for example, see [6 and 16]). A plausible reason for the attention accorded dividend policy would be a relationship between the firm's dividend decision and the level and profitability of its investment decisions. Several studies have addressed this issue, yet the evidence to date has been contradictory. On the one hand, Baumol, Heim, Malkiel, and Quandt [1] conclude that the rate of return on internally-financed investment is significantly lower than on that financed externally. Pye [11] has observed that an abnormally small percentage of firms issued new stock and also paid dividends. Higgins [7] finds dividends to vary positively with earnings and negatively with investment. Existing owners, according to Mehta [9], are unlikely to be indifferent between additional stock issuance and financing through retained earnings (forgone dividends). Wallingford [15, p. 633] indicates that it has been "observed in practice" that "corporate managers view dividend policy as a trade-off against new investments." Each of these findings is consistent with the view that the dividend decision does affect the value of the firm.