Just writing

It's a crazy world out there!

Friday, March 25, 2005

Trying to make common sense out of Modigliani-Miller theorem

Although I still have not fully understood the MM (Modigliani-Miller) rules of dividend policy, but one thing striked my mind. See we make this assumption that keeping investment decisions same, if you tweek with financing policies (raising finance just to pay extra dividends), you cannot cause a increase in share prices. What it means in my opinion is that if some company thinks that by borrowing extra money it can more dividends to shareholders, this is not a sustainable thing. Even the market identifies this and knows that if the company just borrows to pay dividends and not invest in +NPV projects (for which the business was instituted in the first place), you cannot take market for a ride. Just paying dividends and not investing in some useful projects, will just add to interest costs of the company and in coming years this will reflect in the PAT of the company which will lead to fall of share prices later on. So the market expects this to happen in future and hence a real change in share price doesn't happen.

A company is supposed to give the mind or managerial efficiencies (Microeco mein gamma factor) using which public's money would be put to useful purpose and then pay share profits with them.
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If you want to know about MM theorem, just mail me abajaj[at]gmail{dot}com
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