Why would payout policy not affect firm value in an ideal world?
If we hold the company’s investment policy and capital structure constant, then payout policy is a trade-off between cash dividends and the issue or repurchase of common stock. In an ideally simple and perfect world, the choice would have no effect on market value. This is the MM dividend-irrelevance proposition. The controversy centers on the effects of payout policy in our flawed world. A common—though by no means universal—view is that high dividends enhance share price. For example, this could occur if there were unsatisfied clienteles for high-payout stocks. How might differences in the tax treatment of dividends and capital gains affect dividend policy? Instead of paying dividends, the company can repurchase its own stock. The Internal Revenue Service taxes shareholders only on the capital gains that they realize as a result of the repurchase. For many years capital gains were taxed at lower rates than dividend income. If dividend income is seriously tax-disadvantaged, we would e
