Dividends Model: Walter and Gordon’s Model

Walter’s dividend model and Gordon’s dividend model are two widely used models for determining a company’s optimal dividend policy.

Walter’s dividend model: The Walter model, also known as the “dividend irrelevance theory,” suggests that a company’s dividend policy does not affect its value. The model assumes that the cost of capital is constant and that investors are rational and risk-neutral. According to this model, a company’s value is determined solely by its earnings and the risk associated with those earnings. The optimal dividend policy, therefore, is one that maximizes the value of the company, regardless of the amount of dividends paid.

Both the Walter model and Gordon model provide insights into a company’s optimal dividend policy. The Walter model is useful in situations where a company has profitable investment opportunities, and the cost of capital is constant. The Gordon model is useful in situations where a company has limited investment opportunities and where the cost of capital increases as the payout ratio increases.

In practice, most companies use a combination of dividend and reinvestment of earnings to maintain a balance between paying dividends to shareholders and investing in future growth opportunities.