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Paul Asquith and David W. Mullins, Jr.
Paul Asquithand David W. Mullins, Jr., are membersof thefaculty of Harvard University.
* Decisions concerningequity cash flows - diviand equity issues - havedends, stock repurchases, long been the focus of controversyand confusion and The amongacademics financialpractitioners. purpose of this paperis to provideinsightinto the capital markets'reactionto equity cash flow decisions. The natureof the markets'reactionsuggestsa framework for relatingandinterpreting thesedecisions.Although the immediate objectiveof this researchis to measure and understandmarkets'reactionto managerial the decisions,the ultimateobjectiveis to improvecorporatefinancialdecisionmaking.
research shedslighton why financial continmanagers ue to ignorethe advice of professorsand consultants andshowerinvestorswith cash. These studiesclarify the efficacy of dividendsand repurchases vehicles as for communicating information shareholders. to They are suggestthatdividendsandrepurchases perceived as assessment of by investors signalsof management's a company'sperformance prospects. and
A. The Dividend Puzzle
of Summingup our currentstate of understanding dividendpolicy, MartinFeldsteinandJerry corporate Green conclude:"Thenearlyuniversalpolicy of dividendsis the primary payingsubstantial puzzle in the economicsof corporate finance." The puzzle was first posed ina classic paperpublishedin 1961by MertonMillerandFrancoModigliani . Their work demonstrated that, with a given investmentand financing policy, a firm's dividend policy shouldnot affectthe value of its shares(ignorThe the ing all imperfections). logic underlying Miller27
I. The Controversy Surrounding Dividends and Stock Repurchases
A well knownfinancialconsultant fondof saying, is ofdistribution cash by a companyrepresents "Any failure." this definitionNew YorkStockExchange By failedin 1984to thetuneof over$68 billion companies out in cash dividendsand about$77 billion dispaid tributed of through repurchases commonstock.Recent
FINANCIAL MANAGEMENT/AUTUMN 1986
Modiglianitheoremcan be seen in the behaviorof stock prices on ex-dividenddates. On the day a stockgoes...