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Dividend policy: Reconciling DD with MM
ARTICLE IN PRESS
Journal of Financial Economics 87 (2008) 528–531 www.elsevier.com/locate/jfec
Dividend policy: Reconciling DD with MM$ John C. Handley University of Melbourne, VIC, 3010, Australia Received 2 December 2005; received in revised form 9 January 2007; accepted 23 February 2007
Abstract Miller and Modigliani [1961. Dividend policy, growth and the valuation of shares. Journal of Business 34, 411–433] establish the irrelevance of dividend policy in a perfect capital market. DeAngelo and DeAngelo [2006. The irrelevance of the MM dividend irrelevance theorem. Journal of Financial Economics 79, 293–315.] suggest the Miller-Modigliani analysis is flawed and consequently their central conclusion is incorrect. The purpose of this paper is to show the vital role played by stock repurchases and agency costs in reconciling the two opposing views. r 2007 Elsevier B.V. All rights reserved. JEL classification: G35; G32 Keywords: Dividends; Payout policy; Miller-Modigliani
1. Introduction In a controversial paper re-examining the importance of dividend policy in a perfect capital market, and in particular the irrelevance theorem of Miller and Modigliani (1961, MM), DeAngelo and DeAngelo (2006, DD) conclude: the reason why payout policy is irrelevant is that MM’s assumptions require firms to pay out 100% of free cash flow (FCF) in every period. By ruling out retention, MM restrict the feasible set [of payout policies] to optimal policies and thereby ensure irrelevance (p. 296); and When MM’s assumptions are modified to allow retention with the NPV of investment policy fixed, a firm can reduce its value by paying out less than the full present value of FCF, and so payout policy matters and investment policy is not the sole determinant of value (p. 294). DeAngelo-DeAngelo challenge part of the foundational bedrock of modern corporate finance theory. However, close examination reveals that stock repurchases and agency problems play a vital role in their argument. In particular, the validity of their first statement rests on how one treats stock repurchases, and the $
Comments from Harry and Linda DeAngelo, Bruce Grundy, a member of the JFE Editorial Board, and especially the referee are gratefully acknowledged. Tel.: +61 3 83447663; fax: +61 3 83446914. E-mail address: [email protected] 0304-405X/$ - see front matter r 2007 Elsevier B.V. All rights reserved. doi:10.1016/j.jfineco.2007.02.002
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validity of their second statement rests on how one treats agency costs. Accordingly, the Miller-Modigliani irrelevance theorem is not irrelevant as claimed. 2. Does Miller-Modigliani rule out retention? We follow Miller-Modigliani and assume an ideal economy characterized by no transactions costs or differential taxes, no information asymmetries, competitive price-taking, rational behavior, and for simplicity, perfect certainty and all-equity financing. The starting point for the analysis is the identity that in each period t, the sources of cash must equal the uses of cash: X t þ S t ¼ I t þ Dt þ Rt ,
(1)
where X t is cash flow from prior operating decisions, I t is investment expenditure, Dt is dividends paid (to stockholders on record at the start of period t), Rt is stock repurchases, S t is cash raised from stock issues and Dt ; Rt and S t are nonnegative by definition. Trivially rearranging (1) gives X t I t ¼ Dt þ Rt S t ,
(2)
where X t I t is the net cash flow from investment policy in period t and accordingly any changes during the period must satisfy DX t DI t ¼ DDt þ DRt DS t .
(3)
Since cash flow from prior operating decisions is predetermined and investment policy is fixed by assumption, it follows that DDt ¼ DS t DRt : Although DDt ; DS t and DRt are bounded from below by their initial levels, they are unbounded from above. Thus, any increase in dividends can be financed by an increase in stock sales and any reduction in dividends can be accommodated by an increase in repurchases. This is referred to as the substitute financing approach to avoid confounding effects of changes in dividend policy with changes in investment policy.1 It is usually convenient, but not necessary, to fix the firm’s investment policy at I t ¼ I nt , where all positive and no negative NPV projects are undertaken. In this case, the net cash flow from investment policy, X t I nt , now represents the free cash flow in period t, FCF t and (2) becomes2 FCF t þ St Rt ¼ Dt .
(4)
Eq. (4) simply states that if a firm wishes to pay a dividend then it must be financed from either internal sources (free cash flow) and/or external sources (stock issues net of repurchases). Critical to DeAngelo-DeAngelo’s argument is their seemingly innocuous treatment of stock repurchases. Specifically, DeAngelo-DeAngelo focus on the gross distribution or total payout in period t, Pt ¼ Dt þ Rt , whereby (4) becomes FCF t þ St ¼ Pt .
(5)
Since S t X0 by definition, then the total payout in period t never falls below the level of free cash flow in that period, and so Pt XFCF t . Consequently, DeAngelo-DeAngelo conclude that Miller-Modigliani require firms to pay out 100% of free cash flow in every period and thereby prohibit retention (with any excess distribution above the level of free cash flow funded by fairly priced stock issues). However, a different conclusion is reached if one treats a stock repurchase, undertaken to hold the firm’s investment policy constant, as a negative stock issue.3 Since S t ; Rt X0 by definition, then (4) makes clear that a firm can reduce its dividend payout below 100% of free cash flow in any period t, Dt oFCF t , with the ‘‘retained’’ cash immediately used to repurchase stock in order to hold investment policy constant.4 This is just 1
Rubinstein (1976, p.1229). Also see footnote 2 in DeAngelo and DeAngelo (2006, p. 297). 3 As DeAngelo and DeAngelo (2006, p. 300) note, Miller-Modigliani do not mention repurchases, but Fama and Miller (1972, p. 79–81) make it clear that Miller, and Fama as co-author, treated such repurchases as negative stock sales. 4 For example, if St ¼ 0 then a low dividend payout of Dt oFCF t requires stock repurchases of Rt ¼ FCF t Dt to hold investment policy constant. 2
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the mirror image of the case originally presented by Miller-Modigliani.5 Brennan (1971) and Rubinstein (1976) show that an alternative approach to hold the firm’s investment policy constant is for retained cash to be invested in zero-NPV projects. Miller-Modigliani hold the amount of investment constant while BrennanRubinstein hold the NPV of investment fixed. Note that although, in the substitute financing approach of Miller-Modigliani, low dividend payouts require excess free cash flow to be retained in the firm for only an instant before being paid out to buy back stock, there is no logical error in Miller-Modigliani’s analysis of the impact of alternative dividend policies on stockholder wealth. 3. Is the Miller-Modigliani theorem now irrelevant ? By focusing on dividends, Miller-Modigliani establish the irrelevance of dividend policy in a perfect capital market. In contrast, by focusing on total payout, DeAngelo-DeAngelo show that payout policy is not irrelevant in a perfect capital market. DeAngelo-DeAngelo illustrate their proposition with a simple three-date economy in which a firm raises capital and invests at t ¼ 0, which in turn generates free cash flow at t ¼ 1 of FCF 1 and free cash flow at t ¼ 2 of FCF 2 . To avoid confounding effects, DeAngelo-DeAngelo follow Brennan-Rubinstein and assume, in the case of substantial free cash flow and low levels of payout, that retained cash is invested in zero-NPV projects. They argue that the firm can then reduce its value simply by paying out less than the full present value of free cash flow, for example, making distributions of P1 oFCF 1 at t ¼ 1 (with the retained cash of FCF 1 P1 immediately invested in zero-NPV projects) and P2 oFCF 2 at t ¼ 2. Critical to DeAngelo-DeAngelo’s argument is the absence of any automatic ‘‘settling up’’ on the final date. In other words, DeAngelo-DeAngelo assume it is feasible for the firm to avoid making a liquidating distribution at t ¼ 2 equal to the sum of the compounded value of cash retained at t ¼ 1 and the cash retained at t ¼ 2. The key issue then is what happens (or has happened !) to the undistributed cash, for stockholders have a legal entitlement to the residual value of a firm’s assets and therefore any undistributed cash at t ¼ 2 must be distributed to them on liquidation. Of course, if the manager decides to expropriate the cash (or has already done so) then there is nothing left to distribute. It is here that DeAngelo-DeAngelo depart significantly from Miller-Modigliani and Brennan-Rubinstein. Up to this point, it has been assumed that the investment policy of the firm is fixed at the optimal level, I nt , where all positive and no negative NPV projects are undertaken. By definition, agency problems associated with investment policy — the free cash flow/overinvestment problem of Jensen (1986) and the underinvestment problem of Myers (1977) — do not arise since, with zero contracting costs, both stockholdermanager and stockholder-bondholder conflicts are costlessly resolved. However, the Miller-Modigliani irrelevance theorem does not require investment policy to be fixed at the optimal level of investment: it simply requires that investment policy be fixed at some (arbitrary) level. Importantly, once investment policy is fixed then so too is the level of agency costs borne by the stockholders of the firm.6 Miller-Modigliani and BrennanRubinstein assume the full present value of the net cash flow from the firm’s fixed investment policy is paid out and thereby agency costs are held constant. In this case, feasible payout policies are distinguished by differences in the timing of the payout. The payout is accelerated if the firm issues shares or decreases its investment in zero-NPV projects and the payout is delayed if the firm repurchases shares or increases its investment in zero-NPV projects — but common to all policies is the assumption that the net cash flow is eventually fully distributed. Irrelevance holds since all feasible payout policies yield identical stockholder wealth. In contrast, DeAngelo-DeAngelo also assume investment policy is fixed but in addition assume managers may distribute less than the full present value of the net cash flow from that fixed investment policy (i.e., choose a suboptimal payout policy), with the effect that the welfare of stockholders is reduced relative to if full payout had occurred. Certainly, irrelevance does not hold since all feasible payout policies do not yield identical stockholder wealth. However, in this case agency costs have not been held constant but rather vary 5
See Section I of Miller and Modigliani (1961). For example, if investment policy is fixed at the optimal level I t ¼ I nt , then agency costs are assumed to be zero and to remain at that level. If, instead, the firm overinvests and investment policy is fixed at that level, I t 4I nt , then agency costs are assumed to be positive and to remain at that level. 6
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across alternative payout policies.7 Accordingly, DeAngelo-DeAngelo’s result does not render the MillerModigliani dividend irrelevance theorem irrelevant since there is a fundamental difference in their treatment of agency costs. In effect, DeAngelo-DeAngelo ask a different question to that of Miller-Modigliani (and Brennan-Rubinstein), to which they obtain a different answer. 4. Conclusion By focusing on total payouts and not just dividends, DeAngelo-DeAngelo conclude that Miller-Modigliani require firms to pay out 100% of free cash flow in every period and thereby prohibit retention. If instead one focuses on dividends and treat a stock repurchase, undertaken to hold the firm’s investment policy constant, as a negative stock issue, then low dividend payouts are possible and so either Miller-Modigliani’s substitute financing approach or Brennan-Rubinstein’s neutral reinvestment approach can be used to show the irrelevance of dividend policy in a perfect capital market. More fundamentally, DeAngelo-DeAngelo’s conclusion that payout policy is relevant in a perfect capital market does not render the Miller-Modigliani dividend irrelevance theorem irrelevant since there is a fundamental difference in their treatment of agency costs. In this regard, the contribution of DeAngelo-DeAngelo is to highlight the importance, to the MillerModigliani dividend irrelevance theorem, of the assumption that the present value of the net cash flow from the firm’s fixed investment policy is fully paid out. References Brennan, M., 1971. A note on dividend irrelevance and the Gordon valuation model. Journal of Finance 26, 1115–1121. DeAngelo, H., DeAngelo, L., 2006. The irrelevance of the MM dividend irrelevance theorem. Journal of Financial Economics 79, 293–315. Fama, E.F., Miller, M.H., 1972. The Theory of Finance. Dryden press, Illinois. Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance and takeovers. American Economic Review 76, 323–329. Miller, M.H., Modigliani, F., 1961. Dividend policy, growth and the valuation of shares. Journal of Business 34, 411–433. Myers, S.C., 1977. Determinants of corporate borrowing. Journal of Financial Economics 5, 147–175. Rubinstein, M., 1976. The irrelevancy of dividend policy in an Arrow-Debreu economy. Journal of Finance 31, 1229–1230.
7 Other interpretations of the DeAngelo-DeAngelo result are possible. For example, investing retained cash in a zero-NPV project but then failing to pay out the full present value of the net cash flow from that project is equivalent, in cash flow terms, to having invested the retained cash in a negative NPV project. Thus, DeAngelo-DeAngelo also show that if the level of payout forces a firm to invest in negative NPV projects, then the choice of payout policy can affect firm value. In this case, however, investment policy has not been held constant and so any interpretation of the effect of a change in dividend policy is confounded by the change in investment policy.
Journal of Financial Economics 87 (2008) 528–531 www.elsevier.com/locate/jfec
Dividend policy: Reconciling DD with MM$ John C. Handley University of Melbourne, VIC, 3010, Australia Received 2 December 2005; received in revised form 9 January 2007; accepted 23 February 2007
Abstract Miller and Modigliani [1961. Dividend policy, growth and the valuation of shares. Journal of Business 34, 411–433] establish the irrelevance of dividend policy in a perfect capital market. DeAngelo and DeAngelo [2006. The irrelevance of the MM dividend irrelevance theorem. Journal of Financial Economics 79, 293–315.] suggest the Miller-Modigliani analysis is flawed and consequently their central conclusion is incorrect. The purpose of this paper is to show the vital role played by stock repurchases and agency costs in reconciling the two opposing views. r 2007 Elsevier B.V. All rights reserved. JEL classification: G35; G32 Keywords: Dividends; Payout policy; Miller-Modigliani
1. Introduction In a controversial paper re-examining the importance of dividend policy in a perfect capital market, and in particular the irrelevance theorem of Miller and Modigliani (1961, MM), DeAngelo and DeAngelo (2006, DD) conclude: the reason why payout policy is irrelevant is that MM’s assumptions require firms to pay out 100% of free cash flow (FCF) in every period. By ruling out retention, MM restrict the feasible set [of payout policies] to optimal policies and thereby ensure irrelevance (p. 296); and When MM’s assumptions are modified to allow retention with the NPV of investment policy fixed, a firm can reduce its value by paying out less than the full present value of FCF, and so payout policy matters and investment policy is not the sole determinant of value (p. 294). DeAngelo-DeAngelo challenge part of the foundational bedrock of modern corporate finance theory. However, close examination reveals that stock repurchases and agency problems play a vital role in their argument. In particular, the validity of their first statement rests on how one treats stock repurchases, and the $
Comments from Harry and Linda DeAngelo, Bruce Grundy, a member of the JFE Editorial Board, and especially the referee are gratefully acknowledged. Tel.: +61 3 83447663; fax: +61 3 83446914. E-mail address: [email protected] 0304-405X/$ - see front matter r 2007 Elsevier B.V. All rights reserved. doi:10.1016/j.jfineco.2007.02.002
ARTICLE IN PRESS J.C. Handley / Journal of Financial Economics 87 (2008) 528–531
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validity of their second statement rests on how one treats agency costs. Accordingly, the Miller-Modigliani irrelevance theorem is not irrelevant as claimed. 2. Does Miller-Modigliani rule out retention? We follow Miller-Modigliani and assume an ideal economy characterized by no transactions costs or differential taxes, no information asymmetries, competitive price-taking, rational behavior, and for simplicity, perfect certainty and all-equity financing. The starting point for the analysis is the identity that in each period t, the sources of cash must equal the uses of cash: X t þ S t ¼ I t þ Dt þ Rt ,
(1)
where X t is cash flow from prior operating decisions, I t is investment expenditure, Dt is dividends paid (to stockholders on record at the start of period t), Rt is stock repurchases, S t is cash raised from stock issues and Dt ; Rt and S t are nonnegative by definition. Trivially rearranging (1) gives X t I t ¼ Dt þ Rt S t ,
(2)
where X t I t is the net cash flow from investment policy in period t and accordingly any changes during the period must satisfy DX t DI t ¼ DDt þ DRt DS t .
(3)
Since cash flow from prior operating decisions is predetermined and investment policy is fixed by assumption, it follows that DDt ¼ DS t DRt : Although DDt ; DS t and DRt are bounded from below by their initial levels, they are unbounded from above. Thus, any increase in dividends can be financed by an increase in stock sales and any reduction in dividends can be accommodated by an increase in repurchases. This is referred to as the substitute financing approach to avoid confounding effects of changes in dividend policy with changes in investment policy.1 It is usually convenient, but not necessary, to fix the firm’s investment policy at I t ¼ I nt , where all positive and no negative NPV projects are undertaken. In this case, the net cash flow from investment policy, X t I nt , now represents the free cash flow in period t, FCF t and (2) becomes2 FCF t þ St Rt ¼ Dt .
(4)
Eq. (4) simply states that if a firm wishes to pay a dividend then it must be financed from either internal sources (free cash flow) and/or external sources (stock issues net of repurchases). Critical to DeAngelo-DeAngelo’s argument is their seemingly innocuous treatment of stock repurchases. Specifically, DeAngelo-DeAngelo focus on the gross distribution or total payout in period t, Pt ¼ Dt þ Rt , whereby (4) becomes FCF t þ St ¼ Pt .
(5)
Since S t X0 by definition, then the total payout in period t never falls below the level of free cash flow in that period, and so Pt XFCF t . Consequently, DeAngelo-DeAngelo conclude that Miller-Modigliani require firms to pay out 100% of free cash flow in every period and thereby prohibit retention (with any excess distribution above the level of free cash flow funded by fairly priced stock issues). However, a different conclusion is reached if one treats a stock repurchase, undertaken to hold the firm’s investment policy constant, as a negative stock issue.3 Since S t ; Rt X0 by definition, then (4) makes clear that a firm can reduce its dividend payout below 100% of free cash flow in any period t, Dt oFCF t , with the ‘‘retained’’ cash immediately used to repurchase stock in order to hold investment policy constant.4 This is just 1
Rubinstein (1976, p.1229). Also see footnote 2 in DeAngelo and DeAngelo (2006, p. 297). 3 As DeAngelo and DeAngelo (2006, p. 300) note, Miller-Modigliani do not mention repurchases, but Fama and Miller (1972, p. 79–81) make it clear that Miller, and Fama as co-author, treated such repurchases as negative stock sales. 4 For example, if St ¼ 0 then a low dividend payout of Dt oFCF t requires stock repurchases of Rt ¼ FCF t Dt to hold investment policy constant. 2
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the mirror image of the case originally presented by Miller-Modigliani.5 Brennan (1971) and Rubinstein (1976) show that an alternative approach to hold the firm’s investment policy constant is for retained cash to be invested in zero-NPV projects. Miller-Modigliani hold the amount of investment constant while BrennanRubinstein hold the NPV of investment fixed. Note that although, in the substitute financing approach of Miller-Modigliani, low dividend payouts require excess free cash flow to be retained in the firm for only an instant before being paid out to buy back stock, there is no logical error in Miller-Modigliani’s analysis of the impact of alternative dividend policies on stockholder wealth. 3. Is the Miller-Modigliani theorem now irrelevant ? By focusing on dividends, Miller-Modigliani establish the irrelevance of dividend policy in a perfect capital market. In contrast, by focusing on total payout, DeAngelo-DeAngelo show that payout policy is not irrelevant in a perfect capital market. DeAngelo-DeAngelo illustrate their proposition with a simple three-date economy in which a firm raises capital and invests at t ¼ 0, which in turn generates free cash flow at t ¼ 1 of FCF 1 and free cash flow at t ¼ 2 of FCF 2 . To avoid confounding effects, DeAngelo-DeAngelo follow Brennan-Rubinstein and assume, in the case of substantial free cash flow and low levels of payout, that retained cash is invested in zero-NPV projects. They argue that the firm can then reduce its value simply by paying out less than the full present value of free cash flow, for example, making distributions of P1 oFCF 1 at t ¼ 1 (with the retained cash of FCF 1 P1 immediately invested in zero-NPV projects) and P2 oFCF 2 at t ¼ 2. Critical to DeAngelo-DeAngelo’s argument is the absence of any automatic ‘‘settling up’’ on the final date. In other words, DeAngelo-DeAngelo assume it is feasible for the firm to avoid making a liquidating distribution at t ¼ 2 equal to the sum of the compounded value of cash retained at t ¼ 1 and the cash retained at t ¼ 2. The key issue then is what happens (or has happened !) to the undistributed cash, for stockholders have a legal entitlement to the residual value of a firm’s assets and therefore any undistributed cash at t ¼ 2 must be distributed to them on liquidation. Of course, if the manager decides to expropriate the cash (or has already done so) then there is nothing left to distribute. It is here that DeAngelo-DeAngelo depart significantly from Miller-Modigliani and Brennan-Rubinstein. Up to this point, it has been assumed that the investment policy of the firm is fixed at the optimal level, I nt , where all positive and no negative NPV projects are undertaken. By definition, agency problems associated with investment policy — the free cash flow/overinvestment problem of Jensen (1986) and the underinvestment problem of Myers (1977) — do not arise since, with zero contracting costs, both stockholdermanager and stockholder-bondholder conflicts are costlessly resolved. However, the Miller-Modigliani irrelevance theorem does not require investment policy to be fixed at the optimal level of investment: it simply requires that investment policy be fixed at some (arbitrary) level. Importantly, once investment policy is fixed then so too is the level of agency costs borne by the stockholders of the firm.6 Miller-Modigliani and BrennanRubinstein assume the full present value of the net cash flow from the firm’s fixed investment policy is paid out and thereby agency costs are held constant. In this case, feasible payout policies are distinguished by differences in the timing of the payout. The payout is accelerated if the firm issues shares or decreases its investment in zero-NPV projects and the payout is delayed if the firm repurchases shares or increases its investment in zero-NPV projects — but common to all policies is the assumption that the net cash flow is eventually fully distributed. Irrelevance holds since all feasible payout policies yield identical stockholder wealth. In contrast, DeAngelo-DeAngelo also assume investment policy is fixed but in addition assume managers may distribute less than the full present value of the net cash flow from that fixed investment policy (i.e., choose a suboptimal payout policy), with the effect that the welfare of stockholders is reduced relative to if full payout had occurred. Certainly, irrelevance does not hold since all feasible payout policies do not yield identical stockholder wealth. However, in this case agency costs have not been held constant but rather vary 5
See Section I of Miller and Modigliani (1961). For example, if investment policy is fixed at the optimal level I t ¼ I nt , then agency costs are assumed to be zero and to remain at that level. If, instead, the firm overinvests and investment policy is fixed at that level, I t 4I nt , then agency costs are assumed to be positive and to remain at that level. 6
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across alternative payout policies.7 Accordingly, DeAngelo-DeAngelo’s result does not render the MillerModigliani dividend irrelevance theorem irrelevant since there is a fundamental difference in their treatment of agency costs. In effect, DeAngelo-DeAngelo ask a different question to that of Miller-Modigliani (and Brennan-Rubinstein), to which they obtain a different answer. 4. Conclusion By focusing on total payouts and not just dividends, DeAngelo-DeAngelo conclude that Miller-Modigliani require firms to pay out 100% of free cash flow in every period and thereby prohibit retention. If instead one focuses on dividends and treat a stock repurchase, undertaken to hold the firm’s investment policy constant, as a negative stock issue, then low dividend payouts are possible and so either Miller-Modigliani’s substitute financing approach or Brennan-Rubinstein’s neutral reinvestment approach can be used to show the irrelevance of dividend policy in a perfect capital market. More fundamentally, DeAngelo-DeAngelo’s conclusion that payout policy is relevant in a perfect capital market does not render the Miller-Modigliani dividend irrelevance theorem irrelevant since there is a fundamental difference in their treatment of agency costs. In this regard, the contribution of DeAngelo-DeAngelo is to highlight the importance, to the MillerModigliani dividend irrelevance theorem, of the assumption that the present value of the net cash flow from the firm’s fixed investment policy is fully paid out. References Brennan, M., 1971. A note on dividend irrelevance and the Gordon valuation model. Journal of Finance 26, 1115–1121. DeAngelo, H., DeAngelo, L., 2006. The irrelevance of the MM dividend irrelevance theorem. Journal of Financial Economics 79, 293–315. Fama, E.F., Miller, M.H., 1972. The Theory of Finance. Dryden press, Illinois. Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance and takeovers. American Economic Review 76, 323–329. Miller, M.H., Modigliani, F., 1961. Dividend policy, growth and the valuation of shares. Journal of Business 34, 411–433. Myers, S.C., 1977. Determinants of corporate borrowing. Journal of Financial Economics 5, 147–175. Rubinstein, M., 1976. The irrelevancy of dividend policy in an Arrow-Debreu economy. Journal of Finance 31, 1229–1230.
7 Other interpretations of the DeAngelo-DeAngelo result are possible. For example, investing retained cash in a zero-NPV project but then failing to pay out the full present value of the net cash flow from that project is equivalent, in cash flow terms, to having invested the retained cash in a negative NPV project. Thus, DeAngelo-DeAngelo also show that if the level of payout forces a firm to invest in negative NPV projects, then the choice of payout policy can affect firm value. In this case, however, investment policy has not been held constant and so any interpretation of the effect of a change in dividend policy is confounded by the change in investment policy.