Transaction and Inconvenience Costs

Yet another assumption which is open to question is that there are no transaction costs in the capital market. Transaction costs refer to costs associated with the sale of securities by the shareholder investors. The costs postulate implies that if dividend are not paid for earnings are retained, the investors desirous of current income to meet consumption needs can sell a part of their holdings without incurring any cost, like brokerage and so on, This is obviously an unrealistic assumption. Since the sale of securities involves cost, to get current income equivalent to the dividend, if paid, the investors would have to sell securities in excess of the income that they will  receive. Apart from the transaction cost, the sale of securities, as an alternative to current income, is inconvenient to the investors. Moreover, uncertainty , is associated with the sale of securities. For all these reasons, an investor cannot be expected, as MM assume, to be indifferent between dividend and retained earnings. The investors interested in current income would certainly prefer dividend payment to ploughing back of profit by the firm.

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