What are Homemade Dividends?

According to the Miller Modigliani model of dividend theory, shareholders need not depend solely on dividends provided by the parent company to raise cash. They can sell their shares in the market to get the money they want. This is known as a Homemade Dividend because the part of cash generated in the process is not like regular methods. Instead, it is more like a homemade situation which lets the shareholders earn the cash.

  • After the execution of a homemade dividend, shareholders will be left with less rights on the given company and the rights will be transferred to a new shareholder.

  • Neither the company nor the shareholder will lose anything in the process. The value of the shares remains the same in the market and part of the shareholding pattern changes, but overall, there is no change in valuation of a company in terms of dividend distribution.

Shareholders can decide to sell shares in the market to earn homemade dividends anytime they wish and they are legally permitted to do so. However, the prices of shares may change in the market which would either lead to a loss or a gain from the homemade dividend selling process.

  • If the market value of shares is higher than the price they were bought, shareholders will earn a profit.

  • But if the price of shares in the market is lower than the buying price, then the shareholders will get less money or have to sell the shares at a loss.

MM Model of Homemade Dividends

The Miller Modigliani model states that there would be no change in share prices of a particular stock. Thereby, the ultimate effect of selling homemade dividends would result in no loss or profit.

  • The MM model therefore deals only with the change of ownership of the shares.

  • In the homemade dividend process, the original owners are left with less number of shares and the buyer gets increased ownership of the firm due to the ownership of new shares.

  • It is, however, easily understandable that the MM model of homemade dividends is faulty because the prices of shares do not remain the same in the markets. Therefore, when the shares are exchanged, the sellers usually incur either a profit or a loss. Similarly, the buyer of the shares has to either spend a higher or a lower share price depending on the price and performance of the shares in the market.

It is thus explained by the homemade dividend model that selling of shares anytime is possible and hence if shareholders tend to dilute their shares in the market without getting dividend from the parent company, it is absolutely possible for the shareholders to do so.