As a shareholder, would you prefer a small dividend or for the company to reinvest that money into a positive NPV project? There are various theories that talk about the importance of dividends to shareholders, but in reality I think I would prefer the knowledge that the business have projects that they can invest into. After all, if they’re not investing, is the company not becoming stagnant? And that’s the last thing you want as a shareholder!
The main corporate aim of a company is to ‘increase shareholder wealth’, generally you’d probably think the best way to do that is to pay out dividends, which is obviously giving money straight to the shareholder - increasing shareholder wealth.. But in the long run, if a company can invest in projects which are going to generate more value for the company, that will surely have more of an impact on the shareholders and increase their wealth more positively in the long run?
It’s basically a question of would you like a small amount of money risk-free now, or would you like the chance to increase that amount of money by having to wait a longer amount of time for it.
Modigliani and Miller (1961) came up with the Dividend Irrelevance Theory, this is basically saying that a dividend payment isn’t the only thing to affect the share price of a company, investing in +NPV projects will increase the value of the company as well. Although, if dividends are never paid out, then what is the point in having shares in the company. So there has to be a mix.
Shareholders benefit when a company invests in +NPV projects as this can lead to higher future dividends, but it also increases the share price of the company so if they were wishing to sell their shares they would have made a nice profit!
Dividends also have an effect on the economy. Andrew Haldane, Bank of England’s Chief Economist has said that companies paying out dividends are slowing down the economy, they are meeting the short-term needs of the shareholder without taking into account the needs of the wider economy. By investing in projects, it means that money is being circulated and generating more value. If companies aren’t investing and are solely paying out dividends, this means that money is just sitting around doing nothing, and certainly not gaining any value..
Overall, I reckon the key is to invest money into new projects. It increases the value of the company, increases shareholder wealth in the long run and gives the economy a good kick!
Do you all agree?
Do you think that investors are still as willing to invest even when they know there is a lower chance of receiving a dividend payment?
ReplyDeleteI think that it depends on the experience of the investor. Many inexperienced investors, I think, would be less willing to invest where they would know there is a decreased chance of dividend payments. The more experienced investors, however, would have a better understanding of the market and therefore maybe understand more that it can still be wise to invest in a company although there is limited chance of consistent dividend payments as the actual value of the share can still increase and therefore a gain can be made on the investment. It can be a good sign to not get a dividend as it can mean that the company has +NPV projects to invest in.
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