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Miller and Modigliani’s analysis

As we already underlined, the expression “dividend puzzle” refers to the difficulty to ascertain if a dividend payment is compulsory or not. Three theses are presented in the literature: neutrality, payment and non payment. These theses are consistent with Lintner’s previous research (i.e. there is a relationship-correlation, at least in the long term, between profit and dividends). So, we can question if the firm’s value depends (or not) on dividend policy and/or earnings (i.e. corporate performance).

According to financial theory, the firm’s value can be viewed as the expected cash flows of the firm. One can quote, without being exhaustive, Miller and Modigliani (1961), Friend and Puckett (1964), Watts (1973), Fama (1974), Black and Scholes (1974), Black (1976), Rubinstein (1976), Ross (1977) or Miller and Scholes (1982). The analysis of Miller and Modigliani (1961) suggests that investment decisions and dividend policy do not interact. In their study, Miller and Modigliani (1961) highlight the ‘neutrality’ of dividend policy. They find this





⁶ Nissim and Ziv (2001) highlight that earnings (profits) are abnormally high in the two years following an increase in dividends while they (earnings) remain steady after a decline in dividends. They point out that dividend increase is a positive signal of the expected corporate performance and that dividend omission does not allow information about the expected corporate performance to be conveyed.

result using the following assumptions: no difference between dividend tax and tax on profits, no transaction costs, no cost issues and finally non informational asymmetry. In other words, the firm’s value is independent from dividend policy in a perfect market. This approach supports work done by the same authors concerning capital structure; i.e. one does create value only by using debt. Finally, Modigliani and Miller explain why debt (1958) as well as dividend payment do not create value. Thus, dividends do not allow shareholders to become richer because (in theory) dividend payment is offset by the same decrease in share value.

Based on this result, studies which were undertaken later have attempted to check if the neutrality theorem remained valid even if some assumptions were not fulfilled. We will discuss this point and especially the importance of investor heterogeneity (clientele effect and tax effect) (B) and that of the ex-ante and ex-post informational asymmetry (C).

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