Thus, in a subtle
cognitive dissonance, retained earnings - often plundered by rapacious
managers - came to be regarded as some kind of deferred dividends.
The rationale is that retained earnings, once re-invested, generate
additional earnings. Such a virtuous cycle increases the likelihood and
size of future dividends. Even undistributed earnings, goes the
refrain, provide a rate of return, or a yield - known as the earnings
yield. The original meaning of the word "yield" - income realized by an
investor - was undermined by this Newspeak.
Why was this oxymoron - the "earnings yield" - perpetuated?
According to all current theories of finance, in the absence of
dividends - shares are worthless. The value of an investor's holdings
is determined by the income he stands to receive from them. No income -
no value. Of course, an investor can always sell his holdings to other
investors and realize capital gains (or losses). But capital gains -
though also driven by earnings hype - do not feature in financial
models of stock valuation.
Faced with a dearth of dividends, market participants - and especially
Wall Street firms - could obviously not live with the ensuing zero
valuation of securities.
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