Dividend, mergers and acquisitions

Dividend policy decides how much profit to distribute and how much to retain for growth. The irrelevance school (Modigliani-Miller) says that in perfect markets dividend policy does not affect firm value: shareholders who want cash can sell shares, and a firm that pays more must raise the difference from new shares. The relevance school disagrees: Walter's model says dividends matter when return on investment differs from the cost of capital, and Gordon's model says investors prefer certain dividends to uncertain capital gains (the bird-in-hand argument). Worked example: a firm earns 20% on investment while shareholders require 10% — retaining and reinvesting creates more value than paying out, so Walter's model favours a low payout here.