Joanna Woronko 23316, WSB Gdansk Advanced Corporate Finance “The dividend decision is unimportant to the well-being of a company.” Discuss. Once a year many financial managers and owners of corporations meet with a hard nut to crack. They have to decide what part of the earned net profit could be spend on dividends and what part on financing and investments that bring about growth of the company. On the one hand high dividends may be often a sign for shareholders of financial soundness of the company, it can cause a potential growth in the future and positively affect the price of shares on the stock exchange. It can be called a signal effect. Dividend increase sends a good news about cash flow and earnings while dividend decrease sends bad news for investors. On the other hand inappropriate dividend decisions may force a company to take a borrowing decision and in a consequence bring some extra costs of debt. All in all owners have to find a point of balance between dividends and retaining profits. However as Fisher Black wrote twenty years ago: ”The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don't fit together”. Why dividend policy is in fact so complicated? All theories of dividend policy that arose over the years speculate around two main directions: relevance and irrelevance of dividend policy. Is dividend policy a crucial factor in formation of corporate value? If so, how dividend policy affects the market value of the firm? What happens to the value of the firm if dividend increases or if stays constant? To understand better dividend policy would be even worth to explain what the phrases means. Dividend could be defined as a distribution of value to shareholders. Dividend policy concerns mainly the decision: to pay cash dividend now or to pay an increased dividend at a later stage. The dividend could be even paid in a form of stock which don not give investors liquidity but bring capital profits. In very simple words dividend policy is a trade- off between retaining earnings on the one hand and paying out cash dividend and issuing new shares on the other. (Brealey, Meyers, 2003:439) There would be no problem with the dividend decision if we lived in an ideally simple world with perfect marketplace as Modigliani and Miller assumed in 1961 in their theory of dividend irrelevance. In a perfect capital market there is no taxes, no transactions costs, no flotation costs. Informations are also free of costs and widely available for investors which behave rationally. Modigani and Miller controlled and compared the value of the firm when dividends are paid and are not paid. Based on the conditions above and elaborated model they proved that there is no matter for shareholder if they get the profit from dividend or from the growth of share price. According to their model dividend policy pursued by the company does not have any impact on either the cost of equity or the market value of the shares. Dividend irrelevance theory presented by Modigani and Miller is one of the fundamental theories but also one of the most controversial because of totally unrealistic assumptions. (Bernstein, Fabozzi, 1998:10) As a response to M&M theory a number of conflicting theoretical models have been determined. One of the counterpoint was developed by Myron Gordon and John Lintner. It is