Lessons in Corporate Finance

CHAPTER 11 Dividend Policy (Apple Inc.)

This chapter will look at why and how firms return cash to their stockholders in the form of dividends. We will first discuss the theory and empirical facts regarding dividends. Then we will use Apple Inc. (Apple) as an example to discuss corporate dividend policy.

The Theory of Dividend Policy

To discuss the theory behind corporate dividends, we begin (as we often do) with M&M (Miller and Modigliani). With dividends we start with M&M (1961). Let’s assume an M&M world with efficient markets (there is no information asymmetry, i.e., everyone knows everything, and everyone knows it at the same time, zero transaction costs, zero taxes, and costless arbitrage). Remember that we lived in this world when we discussed capital structure in Chapter 6.

In an M&M world, dividend policy does not matter. M&M (1961) shows that dividends are a zero net present value (NPV) transaction (i.e., paying or not paying dividends does not change the value of the firm or the stock). The logic for why dividends don’t matter in an M&M world is simple: an investor in this world is indifferent between owning a stock worth $50 and owning a stock worth $48 plus $2 in cash because the investor can costlessly arbitrage.

The arbitrage argument is that if an individual prefers dividends and the stock they own does not pay dividends, the individual can simulate her own dividends by selling part of her stock. To obtain a 5% dividend, an individual simply needs to sell ...