# What Is Dividend Irrelevance Theory?

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*— Xiaojie Liu / Investopedia*

> **Definition**
>
> Dividend Irrelevance Theory argues that dividend distributions may negatively affect a company's financial health.

## What Is Dividend Irrelevance Theory?

Dividends are distributed from a company’s [profits](https://www.investopedia.com/terms/p/profit.asp) to its [shareholders](https://www.investopedia.com/terms/s/shareholder.asp) as a reward for investing in the company. Many companies pay dividends instead of reinvesting the money to generate [earnings](https://www.investopedia.com/terms/e/earnings.asp).

Some common views hold that dividends help a company’s [stock price](https://www.investopedia.com/articles/stocks/08/stock-prices-fool.asp) to rise. Dividend irrelevance theory posits that [dividends](https://www.investopedia.com/terms/d/dividend.asp) don’t affect a company’s stock price. It argues dividends can hurt a company’s long-term competitiveness.

The theory was developed by economists [Merton Miller](https://www.investopedia.com/terms/m/merton-miller.asp) and [Franco Modigliani](https://www.investopedia.com/terms/f/franco-modigliani.asp) in 1961. The duo are also responsible for the [Modigliani-Miller theorem](https://www.investopedia.com/terms/m/modigliani-millertheorem.asp). Both were awarded the Nobel Prize in Economics.

### Key Takeaways

*   Dividend irrelevance theory suggests that a company’s dividend payments don’t elevate a company’s stock price.
*   The theory argues that dividends hurt a company since the money would be better reinvested.
*   Companies may take on debt to honor dividend payments instead of paying down debt to improve their balance sheet.

## What the Theory Argues

Dividend irrelevance theory suggests that dividends should have little to no impact on a company's stock price. The theory argues that a company’s ability to earn profit and grow determines a company’s market value and drives the stock price.

Dividend irrelevance theory argues that dividends don’t benefit [investors](https://www.investopedia.com/terms/i/investor.asp) and can hurt a company’s financial health. If markets perform efficiently any dividend payout will lead to a decline in the stock price by the dividend amount. If the stock price was $10, and the company paid a dividend of $1, the stock would fall to $9 per share. Holding the stock for the dividend achieves no gain since the stock price adjusts lower for the same amount.

## Dividends and Stock Price

Stocks that pay dividends, like many established companies called [blue-chip](https://www.investopedia.com/terms/b/bluechip.asp) stocks, often increase in price by the amount of the dividend as the [book closure date](https://www.investopedia.com/terms/b/bookclosure.asp) approaches. Although the stock can decline once the dividend has been paid, many dividend-seeking investors [hold these stocks for consistent dividends](https://www.investopedia.com/articles/basics/11/due-dilligence-on-dividends.asp), creating an underlying level of [demand](https://www.investopedia.com/terms/d/demand.asp).

The stock price is driven by more than [the company’s dividend policy](https://www.investopedia.com/terms/l/lintnersmodel.asp). Analysts conduct valuation exercises to determine a stock’s [intrinsic value](https://www.investopedia.com/terms/i/intrinsicvalue.asp). These often incorporate factors, such as:

*   Dividend payments
*   Financial performance
*   Qualitative measurements, including management quality, economic factors, and an understanding of the company’s position in the industry

## Paying for Dividends

A company may take on [debt](https://www.investopedia.com/terms/d/debt.asp), like issuing [bonds](https://www.investopedia.com/terms/b/bond.asp) to investors or borrowing from a bank’s [credit facility](https://www.investopedia.com/terms/c/creditfacility.asp), to make cash dividend payments. Companies that have made acquisitions may hold significant debt on their [balance sheets](https://www.investopedia.com/terms/b/balancesheet.asp). The [debt-servicing](https://www.investopedia.com/terms/d/debtservice.asp) costs or [interest](https://www.investopedia.com/terms/i/interest.asp) payments can be detrimental. Excessive debt can prevent companies from accessing more [credit](https://www.investopedia.com/terms/c/credit.asp).

Proponents of dividend irrelevance theory would argue that a company with substantial debt that insists on paying dividends is hurting itself since dividend payouts could have paid down debt. Less debt leads to favorable credit terms and options to reduce debt-servicing costs.

Debt and dividend payments might prevent the company from making investments that increase earnings in the long term. If a company is not investing in its business through [capital expenditures (CAPEX)](https://www.investopedia.com/terms/c/capitalexpenditure.asp), its valuation may decline as earnings and competitiveness erode. Capital expenditures include purchases of buildings, technology, equipment, and acquisitions.

> **Tip**
>
> Investors who buy dividend-paying stocks must evaluate whether a management team effectively balances paying dividends and investing in a company's future.

## Portfolio Strategies

Despite the dividend irrelevance theory, [many investors focus on dividends](https://www.investopedia.com/articles/fundamental/03/102903.asp) when managing [portfolios](https://www.investopedia.com/terms/p/portfolio.asp). For example, a current income strategy seeks to identify investments that pay above-average distributions with a relatively [risk-averse](https://www.investopedia.com/terms/r/riskaverse.asp) stance.

Strategies focused on income are usually [appropriate for retirees](https://www.investopedia.com/retirement/how-to-manage-timing-and-sources-of-income-retirement/) or risk-averse investors. These income-seeking investors buy stocks in established companies with a track record of consistently paying dividends.

Blue-chip companies like Coca-Cola, PepsiCo, and Walgreens Boots Alliance, [generally pay steady dividends](https://www.investopedia.com/ask/answers/12/why-do-some-companies-pay-a-dividend.asp). Dividends can help with portfolio strategies centered around the [preservation of capital](https://www.investopedia.com/terms/p/preservationofcapital.asp). If a portfolio suffers a loss from a decline in the stock market, the gains from dividends may help offset those losses.

## Why Do Companies Pay Dividends?

Many companies pay dividends as a way to share profits with shareholders.

## How Are Dividends Paid?

In general, dividends are paid in cash. Dividend payments [can also be reinvested](https://www.investopedia.com/articles/investing/080315/how-reinvest-dividends.asp) in the stock distributing them to buy more shares.

## Who Is Eligible for Stock Dividends?

Shareholders who buy or own a company’s stock before the [ex-dividend date](https://www.investopedia.com/terms/e/ex-date.asp) will receive dividends on the payment date. A company’s board of directors determines these dates.

## The Bottom Line

Dividend irrelevance theory maintains that dividend payments don’t impact a company’s stock price. The theory was developed by economists Merton Miller and Franco Modigliani, both Nobel laureates. Critics of the theory argue that a company’s ability to pay out regular dividends signals financial strength and sustainability to investors, which can positively impact a stock’s price.

> **Article Sources**
>
> 1.  The Nobel Prize. “[This Year’s Laureates Are Pioneers in the Theory of Financial Economics and Corporate Finance](https://www.nobelprize.org/prizes/economic-sciences/1990/press-release/).”
>     
> 2.  The University of Chicago, Booth School of Business. “[Why Merton Miller Remains Misunderstood](https://www.chicagobooth.edu/review/why-merton-miller-remains-misunderstood).”
>     
> 3.  Morningstar. “[What to Make of the Buyback Bonanza](https://www.morningstar.ca/ca/news/191094/what-to-make-of-the-buyback-bonanza.aspx).”