Question

Your manager tells you: “Most of our stock holders are large, non-profit institutions who are very activist towards their holdings. Our firm’s earnings look to be negative over the next few years, but I believe we will have a lot of good investment opportunities over the next few years. As a result, I think our payout should be low or zero for now.” Do you agree or disagree with your manager’s statement?

Agree, because payout policy does not matter according to Modigliani and Miller.

Agree, because holding onto more cash now lowers our future issuance costs.

Disagree, because the free cash flow problem is likely to be large as non-profit investors do not care about firm profitability.

Disagree, because large institutions prefer steady dividends.

Answer 1

Agree because  payout policy does not matter according to Modigliani and Miller.

Investors do not really care about the dividend poilicy since they can get higher returns even by selling their stocks and generating their own cash flows.

Option 2 is invalid since the company is not looking to reduce issuance costs.

Option 3 is wrong since large investors also care about the growth rate of the firm.

Option 4 is invalid since large investors care both about dividend and growth. They want higher return either ways.