THE JOURNAL OF BUSINESS The Graduate School of Business of the University of Chicago VOL. XXXIF OCTOBER 1961 No 4 DIVIDEND POLICY, GROWTH, AND THE VALUATION OF SHARES* MERTON H MILLERT AND FRANCO MoDIGLIANIt [E effect of a firms dividend policy of dividend policy. Lacking such a state on the current price of its shares is a ment, investigators have not yet been matter of considerable importance, able to frame their tests with sufficient not only to the corporate officials who precision to distinguish adequately be must set the policy, but to investors tween the various contending hypothe planning portfolios and to economists ses. Nor have they been able to give a seeking to understand and appraise the convincing explanation of what their test functioning of the capital markets. Do results do imply about the underlying companies with generous distribution process of valuation. policies consistently sell at a premium In the hope that it may help to over- over those with niggardly payouts? Is the come these obstacles to effective empiri reverse ever true? If so, under what con- cal testing, this paper will attempt to fill ditions? Is there an optimum payout the existing gap in the theoretical litera- ratio or range of ratios that maximizes ture on valuation. We shall begin, in Sec the current worth of the shares? tion I, by examining the effects of differ Although these questions of fact have ences in dividend policy on the current been the subject of many empirical stud- price of shares in an ideal economy char ies in recent years no consensus has yet acterized by perfect capital markets,ra been achieved. One reason appears to be tional behavior, and perfect certainty the absence in the literature of a com- Still within this convenient analytical plete and reasonably rigorous statement framework we shall go on in Sections II of those parts of the economic theory of and iii to consider certain closely related valuati on bearing directly on the matter issues that appear to have been respon- The authe who read and comment pns of.an sible for considerable misunderstanding their thanks of the role of dividend policy. In d especially to lar. Section II will focus on the long onsiderable simplification of a number of the proofs. standing debate about what investor Professor of finance and economics, University "really "capitalize when they buy shares Professor of economics, Northwestern Univer- and Section III on the much mooted rela tions between price, the rate of growth of his content downloaded from 202.. 18.13 on Wed, 1 1 Sep 2013 02: 04: 42 AM All use subject to JSTOR Terms and ConditionsTHE JOURNAL OF BUSINESS The Graduate School of Business of the University of Chicago VOL. XXXIV OCTOBER 1961 No. 4 DIVIDEND POLICY, GROWTH, AND THE VALUATION OF SHARES* MERTON H. MILLERt AND FRANCO MODIGLINIt Tz i~xeffect of a firm's dividend policy on the current price of its shares is a matter of considerable importance, not only to the corporate officials who must set the policy, but to investors planning portfolios and to economists seeking to understand and appraise the functioning of the capital markets. Do companies with generous distribution policies consistently sell at a premium over those with -niggardly payouts? Is the reverse ever true? If so, under what con￾ditions? Is there an optimum payout ratio or range of ratios that maximizes the current worth of the shares? Although these questions of fact have been the subject of many empirical stud￾ies in recent years no consensus has yet been achieved. One reason appears to be the absence in the literature of a com￾plete and reasonably rigorous statement of those parts of the economic theory of valuation bearing directly on the matter of dividend policy. Lacking such a state￾ment, investigators have not yet been able to frame their tests with sufficient precision to distinguish adequately be￾tween the various contending hypothe￾ses. Nor have they been able to give a convincing explanation of what their test results do imply about the underlying process of valuation. In the hope that it may help to over￾come these obstacles to effective empiri￾cal testing, this paper will attempt to fill the existing gap in the theoretical litera￾ture on valuation. We shall begin, in Sec￾tion I, by examining the effects of differ￾ences in dividend policy on the current price of shares in an ideal economy char￾acterized by perfect capital markets, ra￾tional behavior, and perfect certainty. Still within this convenient analytical framework we shall go on in Sections II and III to consider certain closely related issues that appear to have been respon￾sible for considerable misunderstanding of the role of dividend policy. In particu￾lar, Section II will focus on the long￾standing debate about what investors "really" capitalize when they buy shares; and Section III on the much mooted rela￾tions between price, the rate of growth of * The authors wish to express their thanks to all who read and commented on earlier versions of this paper and especially to Charles C. Holt, now of the University of Wisconsin, whose suggestions led to considerable simplification of a number of the proofs. t Professor of finance and economics, University of Chicago. t Professor of economics, Northwestern Univer￾sity. 411 This content downloaded from 202.115.118.13 on Wed, 11 Sep 2013 02:04:42 AM All use subject to JSTOR Terms and Conditions