- Marris Model
- Applying Marris
- Key Points
Marris Model
In his original model, Marris advocated that corporate growth, g, could be manipulated to maintain an optimum dividend-to-profit retention ratio that keeps the shareholders satisfied but does not retain too high a level of profit, creating a cash-rich business ripe for a take-over. This implies a degree of control on share value that would seem difficult to sustain for even the most effective management team. There are simply too many other factors that could affect the valuation ratio of the business beyond corporate growth. Deciding on how best to achieve growth becomes a crucial issue for management during the life cycle of a firm. For example, if management wish to grow by product diversification there is a constraint inherent in the Marris model, the gd equation, that is fairly acute for firms that opt to grow through product diversification rather than by acquisition:
Where d is the dividend rate and the parameter k represents the percentage of successful new products. The k parameter ultimately depends on R&D, advertising and promotion; and the $ spend on these variables depends on the profits that ultimately depend on the efficiency of the firm.
Agency costs
There is a benchmark rule: the higher the valuation of a company the less likely is the threat of takeover. This rule, however, intimates that dividends should stay high to maintain the share price. Alternatively management may wish to invest more profits to secure more growth with a risk that the value of the company falls. If the higher valuation were perceived by shareholders to be at a maximum then shareholders would prefer that higher valuation, so it behoves management to persuade shareholders that the risk of a fall in value can be captured by a higher growth rate. Management inability to persuade shareholders gives rise to agency costs.
One way to tackle the agency costs is for management to design a trust mechanism between shareholder and management, and thus enabling shareholders to entrust money to management with a reasonable expectation of getting something back. Both recognise that there is a connection between the level of dividends paid out and the company’s growth rate. If the company uses its profits to pay dividends, it retains less money in the business. It therefore has less available to finance new investment in its products.
The diagram shows that there is a trade-off between the proportion of profit paid out by the firm and how much it can grow - every time the firm reduces the dividend proportion by moving down the vertical-axis, it can finance extra growth. The key issue for shareholders is whether or not the investment being financed by paying out less in current dividends eventually produces more profits and future dividends. Shareholders have to trust management.
Positive Learning Transfer
A central theme is designing trust is the context of the management decision, that is, how the decision is observed by shareholders. Shareholders may adopt a Bayesian-type rule, seeing what they want to see about management and the firm. Management should resist this. How? They could signal a positive learning transfer to shareholders whereby management with prior experience (in games with) value-growth issues introduce positive expectations of a stronger performance (higher value for the firm).
This could be achieved through persuading shareholders to view the decision as a continuum rather than as a dichotomy. In other words, the decision has to be framed as a decision about more growth and higher value and not about less value and more growth. Shareholders can then observe the decision of management as a chance wherein making a gain in circumstances where they trust management outweighs the risk of making a loss. Neither extremes are satisfactory in the diagram. However there is a point of maximised growth, g*, which can be achieved in the Marris model but there is a trade-off in terms of dividends and the success of any new products as monitored by the k factor in the gd equation is crucial to sustaining the future level of profits.
How to apply Marris
Consider the following storybook: the key driver of management behaviour within a Marris-type firm is the desire to maximise the capitalisation of the firm subject to a market value of the equity that is greater than the net book value of the net assets. This definition is more relevant for capital-intensive firms rather than people intensive businesses whose values are not represented in the financial statements. Nonetheless, the Marris model can be applied to companies where management are considering organic growth.
The utility or indifference line, illustrated by U, represents a management trade-off between valuation ratio on the Y-axis and the growth rate on the X-axis. It can be any two variables. As argued, more growth can be achieved but at the risk of a lower company valuation. The optimal point is a point Y with a growth of G2.
Check the Unit 1 Study Guides to see the trade-off between profit and market share. The utility or indifference line could represent the p/e ratio of the company or its share price; whatever variable is represented by the utility or indifference line it is very much at the discretion of management. Different management will have different variables.
So, let it be market share. As you move up (down) the utility or indifference lines market share increases (decreases). So at G2, for example, market share is greater than at G1 although the valuation ratio is greater at G1. The Marris firm will seek to control all aspects of the value chain and may also engage in conglomerate diversification in an effort to maximise the market value of equity under management’s control.

Go To Signalling and Read Diageo Case: This will be further discussed at Workshops.
Key Points
To illustrate the mechanics of the Marris model in terms of dividends and growth.
To understand the link between the binary choice of less dividends today for an expected return and greater dividends based on future growth of the company.