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Potential dividends versus actual cash flows in firm valuation

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  • Carlo Alberto Magni
  • Ignacio Velez-Pareja

Abstract

Practitioners and some academics use potential dividends rather than actual payments toshareholders for valuing a firm´s equity. We underline the differences between the two methods and present some arguments supporting the thesis that firm valuation with potential dividends overstate the actual value of the firm´s equity. In particular, consistently with DeAngelo and DeAngelo (2006, 2007), we underline that cash flows create value for shareholders only if they are withdrawn from the firm, and that the use of potential dividends may lead to contradictions.

Suggested Citation

  • Carlo Alberto Magni & Ignacio Velez-Pareja, 2009. "Potential dividends versus actual cash flows in firm valuation," Proyecciones Financieras y Valoración 5516, Master Consultores.
    • Handle: RePEc:col:000463:005516
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    References listed on IDEAS

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    1. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
    2. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    3. James E. Smith & Robert F. Nau, 1995. "Valuing Risky Projects: Option Pricing Theory and Decision Analysis," Management Science, INFORMS, vol. 41(5), pages 795-816, May.
    4. Magni, Carlo Alberto, 2007. "Relevance or irrelevance of retention for dividend policy irrelevance," MPRA Paper 5591, University Library of Munich, Germany.
    5. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    6. Varian, Hal R, 1987. "The Arbitrage Principle in Financial Economics," Journal of Economic Perspectives, American Economic Association, vol. 1(2), pages 55-72, Fall.
    7. Harry DeAngelo & Linda DeAngelo, 2007. "Payout Policy Pedagogy: What Matters and Why," European Financial Management, European Financial Management Association, vol. 13(1), pages 11-27, January.
    8. Stephen H. Penman & Theodore Sougiannis, 1998. "A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity Valuation," Contemporary Accounting Research, John Wiley & Sons, vol. 15(3), pages 343-383, September.
    9. Tham, Joseph & Velez-Pareja, Ignacio, 2004. "Principles of Cash Flow Valuation," Elsevier Monographs, Elsevier, edition 1, number 9780126860405.
    10. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411-411.
    11. DeAngelo, Harry & DeAngelo, Linda, 2006. "The irrelevance of the MM dividend irrelevance theorem," Journal of Financial Economics, Elsevier, vol. 79(2), pages 293-315, February.
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    Cited by:

    1. Bassam M. ABU-ABBAS, 2021. "The Role of Dividends on Equity Valuation: Evidence from the GCC Countries," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 162-180, June.
    2. Harish Kumar Singla & Anand Prakash, 2021. "Financial determinants of value based performance of construction firms in India," International Journal of Productivity and Performance Management, Emerald Group Publishing Limited, vol. 72(4), pages 1025-1050, October.

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    More about this item

    Keywords

    Cash flows; cash flow to equity; liquid assets; potential dividends; firm valuation; equity value; miller and modigliani;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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