Optimal Dividend Policies and Corporate Growth

Abstract

Summary In this paper we discuss the problem of determining an optimal dividend policy for a company having a set of shareholders with specified preferences. The yield opportunities on the capital invested in the company are stylized in that we assume that the company can only invest in two capital assets: one with a stochastic rate of return and one with a secure rate of return. We then discuss how the optimal dividend policy depends on the secure rate of return and on the riskiness of the random rate of return. Finally, the horizon effects on the optimal policies are discussed. In this paper we shall study the problem of determining an optimal dividend policy for a company with a random rate of return on investments and having a set of shareholders with specified preferences. By a dividend policy we shall understand a rule which completely determines the payments to be made to the holders of the company's common stock at any point in time. An optimal policy will consequently mean a dividend payment rule which maximizes some utility criterion as defined by the shareholders' preferences. The crux of the dividend problem is obviously how to represent the shareholders' preferences by a collective utility function representing the constituent individual preferences in a consistent manner. However, we shall circumvent the problems involved in collective choice and group decision-making by assuming that the shareholders' individual utility functions are identical. This assumption may not be so strong as it looks like at a first glance, as the shareholders who do not agree with the company's policy, can sell their shares and buy shares in other companies pursuing a policy that corresponds better to their individual preferences.