Explain Modigliani and Miller's theory of dividends

Modigliani and Miller theory of dividend

Modigliani and Miller (MM approach) says that in perfect world with no taxes cost the dividend policy is irrelevant. The theory states that a firm dividend policy as no effect on value of the firm or shareholders wealth. When a company pays dividend the market price of share increases as a result of this supply of share increase in the market. Consequently price of share decrease thus whatever increase to place in the price of shares through payment of dividend get nullified due to increasing supply of shares.

MM theory says that if dividend is more than expected the investor reinvest the company with surplus cash flow. And if expected dividend is small, then a part of share. In both case investor irrelevant to dividend policy for the reason of investor create their own cash flows.

MM theory believe that company ability to earn money that impact on value of company. And if market condition are perfect, the company does not care return from dividend.