Explain the Lintner Hypothesis.

Explain the Lintner Hypothesis.

Assess the Evidence that Dividend Policy Affects Share Price.

Introduction

Why is dividend policy such an important topic? Payout policies affect almost every party involved in the financial world, from corporations having to deal with equity financing and investment decisions to shareholders seeking information regarding the firms they are funding and the form and amount of their returns, to potential investors deciding where to invest, to academics and analysts seeking to gain a better understanding on policies and the economy. Dividends have been a hotspot of research regarding corporate policies, valuation of firms and market reactions. This paper is intended to delve into one of the more controversial aspects regarding whether payout policy has an effect on the valuation of firms. To do this I will examine two highly influential models regarding this topic. First, I will review Myron J. Gordon’s paper on the discounted dividends approach to firm valuation, which contends that a firm’s dividend policy does influence their value. Secondly I will look over a model put forth by Modigliani and Miller that challenges Gordon’s assertion and instead claims that dividend policy is irrelevant to a firm’s valuation. Additionally this paper will examine the very influential work done by John Lintner regarding the process in which firms determine their dividend policy. Finally, using current empirical evidence, I will assess the relevance and accuracy of these models given the current climate of the financial world.

Gordon and Modigliani and Miller: Dividend Policy’s Affect on Share Price

In 1959, Myron J. Gordon published a theoretical model that he developed to value ordinary equity shares. Gordon’s model contended that the value of a firm increases as the sum of its future dividends increase. This model employs the discounted dividends approach to firm valuation, in which the future cash flows of the stocks are discounted to...