Dividends versus Share Repurchase

Abstract

To what extent should the board of directors and top management consider the immediate effect on stock price of the firm's distribution policy? The conclusions of this article are consistent with those of the well-known Black–Scholes option pricing model—a firm's underlying profitability affects its long-term stock price, not its dividend policy decisions. Beyond the short-run effect on investors who are selling the firm's shares, one should not consider the stock price effect of the distribution policy. If the stock price was initially a fair price, the firm cannot sustain the increased price because of the market psychology regarding a dividend increase. If an increased stock price were sustained, then the holders of the stock would earn below-market required returns.

TOPICS: Legal and regulatory issues for structured finance, accounting and ratio analysis, statistical methods