Thus, we firmly establish the distinction between low payout and high payout companies, capital gains and

dividends. Another important point that deserves attention is that dividends in most countries attract higher taxes. Therefore it is quite plausible that some investors would prefer high-payout companies while others may prefer low-payout companies. How do we define dividend policy? Its the decision for the firm to pay out earnings versus retaining and reinvesting them Now that we know that there exists a relationship between dividend policy and value of the firm. Being an investor, what we should prefer high payouts or low payouts? If we prefer a high payout, we dont trust future and we want to enjoy all the benefits today. So we dont want to take the risk. In the case we prefer low pay out; we want the firm to grow with new investment opportunities using our money since we know that retained earnings are comparatively cheaper. See, it is very difficult to specify. We have different theories bases on differing opinions of the analysts; some consider dividend decision to be irrelevant and some believe dividend decision to be an active variable influencing the value of the firm. Let us study these theories one by one. Traditional theory According to the traditional theory put forward by Graham and Dodd, the capital market attaches considerable importance on dividends rather than on retained earnings. According to them the capital markets are overwhelmingly in favour of liberal dividends as against conservative or too low dividends The following valuation model worked out by them clearly confirms the above view P = M (d + e / 3)

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