Dividend Policy

12 Key excerpts on "Dividend Policy"

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  eBook - ePub

  Financial Management Practices in India

  • Sandeep Goel(Author)
  • 2016(Publication Date)
  • Routledge India

    (Publisher)

  Part V Dividend Decision Passage contains an image

  23 Dividend Policy An overview

  DOI: 10.4324/9781315658896-28

  Introduction

  Shareholder value maximisation implies increase in the wealth of shareholders by the company in the form of high returns. Returns comprise both dividend yield and capital yield. Dividend yield arises when company regularly pays dividend to shareholders in relation to the surplus. Capital gain arises when company shows high business performance which is reflected in the stock market by increase in the market price. So, it is a planned strategy by the management to magnify the returns to shareholders by outperforming the accepted benchmarks. Dividend Policy plays an important role in this. Here, the importance of an adequate Dividend Policy is stressed upon.

  Dividend Policy

  It is the decision of the management with regard to the profits to be distributed as cash dividends and part to be reinvested for future growth. It also involves deciding about the payment in the form of stock dividends to the stockholders. The expectations of dividends by shareholders help them in determining the share value; therefore, Dividend Policy is a significant decision taken by the financial management of any company.

  Dividend theory

  There are various theories which explain the relationship between firm’s Dividend Policy and stock value.

  1 Dividend irrelevance theory

  This theory states that a firm’s Dividend Policy has no effect on either its value or its cost of capital. Investors do not value dividends with regard to the market price of a share.

  a Modigliani and miller's hypothesis

  According to Modigliani and Miller (MM), Dividend Policy of a firm is irrelevant as it does not affect the wealth of the shareholders. They argue that the value of the firm depends on the firm’s earnings which result from its investment policy.

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  Applied Corporate Finance

  • Aswath Damodaran(Author)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  C HAPTER 10 D IVIDEND P OLICY Learning Objectives 10.1. Review basic aspects of Dividend Policy, including the dividend payment process, mea-sures of dividends, and historic patterns in dividend policies. 10.2. Examine the argument that dividends are value neutral. 10.3. Examine the argument that dividends destroy value for stockholders, when the tax law is skewed against dividends. 10.4. Examine the argument that dividends can increase value for some firms. 10.5. Discuss the determinants of Dividend Policy from the perspective of managers. At regular intervals, every publicly traded company has to decide whether to return cash to its stockholders and, if so, how much in the form of dividends. The owner of a private company has to make a similar decision about how much cash he or she plans to withdraw from the business and how much to reinvest. This is the dividend decision, and we begin this chapter by providing some background on three aspects of Dividend Policy. One is a purely procedural question about how dividends are set and paid out to stockholders.

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  Corporate Finance

  Theory and Practice in Emerging Economies

  • Sunil Mahajan(Author)
  • 2020(Publication Date)
  • Cambridge University Press

    (Publisher)

  Having satisfied its need for investment in value-accretive projects, the remaining earnings must be returned to the shareholders. While this may be the fundamental theory, there are several other factors that are relevant in determining the Dividend Policy. For instance, shareholders do not like volatility in dividends. They prefer dividends to be assured and certain. Any variation in the amount of dividends received is not perceived favourably. John Lintner had in 1956 undertaken an extensive survey of the dividend practices of companies. The conclusions he arrived at continue to be valid even after six decades have elapsed! Lintner Model of Dividend Policy and Practice One of the most critical findings of the Lintner survey was that shareholders like to receive stable and predictable dividends. They dislike frequent changes. Conforming to the shareholders’ preferences, companies establish a stable Dividend Policy based on long-term trends in profitability, investments and cash flows. They do not change their dividend payout, consequent to a change in performance that may not be permanent and assured. They need to pay stable dividends while facing a rather volatile profitability scenario. Therefore, the Dividend Policy is a conservative policy that takes into account long-term performance, profitability, investment requirements and cash flow availability. Sudden changes in these variables do not impact dividend payouts; only permanent, sustainable, long-run changes do. The Lintner survey further documents that shareholders are more concerned about changes in dividend than their absolute levels. Is a ₹10 dividend paid by a company significant? The answer depends on the last year’s dividend; it is significant if the last year’s dividend was ₹8 and a non-event if it was ₹10. Consequently, managers do not vary dividend payouts that they are unsure of continuing, in particular a dividend increase that may have to be reversed later.

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  Financial Management

  An Introduction

  • Jim McMenamin(Author)
  • 2002(Publication Date)
  • Routledge

    (Publisher)

  In this context, where the payment of dividends (like the raising of debt finance in the capital structure debate), at least in an indirect way, leads to the activities of managers being subjected to closer external investigation, then dividend (and financing) policy may indeed have a beneficial effect on the value of the firm. Agency cost theory would imply that firms adopt high dividend payout policies, after all suitable investment projects have been financed.

  The mainstream, modern view of Dividend Policy emphasises the valuable role of Dividend Policy in helping to resolve the agency problem and thus in enhancing shareholder value.

  Practical Considerations in the Formulation of Dividend Policy

  As we discussed in relation to the theories of capital structure, there are a range of practical considerations which will influence a company's Dividend Policy. These include:

  Profitability and liquidity

  A company's capacity to pay dividends will be determined primarily by its ability to generate adequate and stable profits and cash flows. As dividend payments represent cash outflows, a company which is not earning profits and/or has liquidity problems, will experience difficulties in sustaining dividend payments.

  Legal and contractual

  As previously indicated, under company law, dividends can only be paid out of distributable profits. Alternatively a company's Dividend Policy may be restricted by covenants on loan agreements. To protect their interests, lenders may impose restrictions limiting the amount of dividends which a company can pay out. In other cases government, or industry regulators (e.g. Ofwat, the water industry regulator), may introduce legislation or regulations which will, directly or indirectly, require companies to restrict dividend payments to shareholders.

  Taxation

  Corporate Dividend Policy is likely to be influenced by the tax regime of the country in which the company operates. An individual country's taxation system may have a favourable, unfavourable, or even neutral, effect on Dividend Policy.

  In the tax regimes of many countries, the income from dividends and the capital gains on the disposal of shares are taxed at differential rates. Usually, the effect of the tax system (after adjusting for allowances and exemptions) is that income from dividends is effectively taxed at a higher rate than capital gains.

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  Dividend Policy

  Theory and Practice

  • George Frankfurter, Bob G. Wood, James Wansley(Authors)
  • 2003(Publication Date)
  • Academic Press

    (Publisher)

  1 See, for example, Norton (1912), Smith (1923),Van Strum (1925), and Harold (1934). Preinreich (1932) was the first to suggest that Dividend Policy is merely a residual decision. Dividends are paid to shareholders if and only if revenues remain after all positive investment opportunities have been funded. Another method determines dividend payout by examining and estimating corporate con-tingencies and financial needs rather than more rudimentary approaches based simply on current funds availability or historical payout patterns (Sage, 1937). Following the strong language of Graham and Dodd (1934) that the cor-poration’s main objective is to pay the owners of the firms (the shareholders) dividends, a preference for issues that pay regular cash dividends became the pre-vailing investment strategy in the financial community. A dollar paid as a cash dividend was shown to increase a share’s price four times as much as a dollar retained [see, e.g., Auerbach (1979) and Bradford (1979)]. Dividend multiples became the preferred method for share valuation by both amateurs and profes-sional money managers. Harkavy (1953) showed empirical support for Graham and Dodd’s posi-tion by estimating a positive correlation between stock price and dividend payout. However, Walter (1956), Gordon (1959), and Solomon (1963) were the first to build a theoretical model for this relationship. The underlying logic of their identical models is the notion that over the long term, share price is the present value of expected dividends. Investors are willing to pay increased price premiums for issues with consistent dividend growth because received cash div-idends are less risky than future capital gains or higher expected dividend pay-ments. Accordingly, Dividend Policy is relevant in firm valuation (Gordon, 1959, 1962). Many refer to these similar models with the generic name of bird in the hand.

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  Essentials of Corporate Finance

  • Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  In Chapter 14, we discussed factors that influence capital struc- ture decisions at firms. In this chapter, we look at some differ- ent but related financing decisions—those concerning how and when to return value (cash or other assets) to stockholders. We begin by describing the various types of dividends and the dividend payment process. We then discuss stock repur- chases as an alternative to dividends. Stock repurchases are a potential component of any payout policy because, like divi- dends, they are a means of distributing value to stockholders. We next examine the benefits and costs associated with making dividend payments and describe how stock prices react when a company makes an announcement about fu- ture dividend payments. These discussions provide insights into the ways in which payout policies affect firm value. We end this part of the chapter by directly comparing the ben- efits and costs of dividends with those of stock repurchases. We then describe stock splits and stock dividends and dis- cuss the reasons managers might want to split their com- pany’s stock or pay a stock dividend. Finally, we conclude the chapter with a discussion of factors that managers and their boards of directors consider when they set payout policies. CHAPTER PREVIEW 15.1 DIVIDENDS Decisions concerning whether to distribute value to stockholders, how much to distribute, and how best to distribute it are very important financing decisions that have implications for a firm’s future investment and capital structure policies. Any time value is distributed to a firm’s stockholders, the amount of equity capital invested in the firm is reduced. Unless the firm raises additional equity by selling new shares, distributions to stockholders reduce the avail- ability of capital for new investments and increase the firm’s financial leverage. The term payout policy refers to a firm’s overall policy regarding distributions of value to stockholders.

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  Finance for Strategic Decision-Making

  What Non-Financial Managers Need to Know

  • M. P. Narayanan, Vikram K. Nanda(Authors)
  • 2004(Publication Date)
  • Jossey-Bass

    (Publisher)

  113 5 Payout Policy T he flip side of equity financing—discussed in Chapter Four—is the distribution of cash by the firm to its share-holders. Such payouts are common and take the form of dividend payments and share repurchases. Firm payout and fi-nancing policies are inextricably linked since, for instance, larger payouts will tend to increase the external financing that a firm needs to raise. The framework developed in the context of financ-ing—that of corporate decision making in the context of imper-fect markets—also makes it easier to understand the role and impact of payout policy. Managers have considerable discretion in paying out cash to shareholders, since equity, unlike debt, comes with no explicit 114 Finance for Strategic Decision Making payment obligations. As a consequence, the factors that influence a firm’s payout policy can be quite subtle. In this chapter, our objective is to understand the nature and trade-offs involved in the choice of a cash payout policy. After discussing the two forms of payout and the general purposes that they serve, we provide a brief guide to creating and maintaining a payout policy. After that we present a case in which financing decisions and payout decisions are crucially connected, illustrating what happens when a firm in need of capital faces an unattractive choice between raising equity capital or cutting back on dividend payments. ■ Payouts and Their Rationale First, here is a closer look at the two forms of payout. Then we discuss why payouts in general matter. Dividends and Share Repurchases Firms distribute cash in two ways: by dividends and by share repurchases. Historically dividends have been the predominant form of corporate cash payout to shareholders. However, as part of a trend starting in the mid-1980s, share repurchases have be-come comparable to dividends in terms of total cash flow from firms to shareholders.

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  Financial Analysis, Planning and Forecasting

  Theory and Application

  • Alice C Lee, John C Lee;Cheng F Lee;;(Authors)
  • 2009(Publication Date)
  • WSPC

    (Publisher)

  16.5. Summary and Conclusions In this chapter, we examined many of the aspects of Dividend Policy, primarily from the relevance-irrelevance standpoint, and from multiple pricing-valuation frameworks. From the Gordon growth model, or classical valuation view, we found that Dividend Policy was not irrelevant, and that increasing the dividend payout would increase the value of the firm. Upon entering the world of Modigliani and Miller where some ideal conditions are imposed, we found that dividends were only one stream of benefits we could examine in deriving a value estimate. However, even in their own empirical work on those other benefit streams, M&M were forced to include dividends, if only for their information content. Building on the Sharpe, Lintner, and Mossin CAPM derivations, Brennan showed that dividends would actually be determinantal to a firm’s cost of capital as they impose a tax penalty on shareholders. While this new CAPM is useful, however, Brennan considered only the effects asso-ciated with the difference between the original income tax and the capital-gains tax. Litzenberger and Ramaswamy extended Brennan’s model by Dividend Policy and Empirical Evidence 673 introducing income, margin, and borrowing constraints. Their empirical results are quite robust, and show that higher and lower dividends mean different things to different groups of investors. Option-pricing theory was shown to make dividends a valuable com-modity to investors due to the wealth-transfer issue. The theory (and the method) of dividend behavior also showed dividend forecasting to have pos-itive value in financial management. In sum, we conclude that dividends policy does generally matter, and it should be considered by financial man-agers in doing financial analysis and planning. The interactions between Dividend Policy, financing, and investment policy will be explored in the next chapter.

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  CFIN

  • Scott Besley, Eugene Brigham, Scott Besley(Authors)
  • 2021(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Thus, if the dividend irrelevance theory is correct, there exists no optimal Dividend Policy, because dividend pol- icy does not affect the value of the firm. 1 On the other hand, it is quite possible that in- vestors do prefer one div- idend policy to another; if so, a firm’s Dividend Policy is relevant. For example, it has been ar- gued that investors pre- fer to receive dividends today because current 13-1 Dividend Policy AND STOCK VALUE How do Dividend Policy decisions affect a firm’s stock price? Academic researchers have studied this question extensively for many years, and they have yet to reach definitive conclusions. On the one hand, there are those who suggest that Dividend Policy is irrelevant because they argue a firm’s value should be determined by the ba- sic earning power and business risk of the firm, in which case value depends only on the income (cash) produced, A firm’s Dividend Policy involves the decision whether to pay out earnings or to retain them for reinvestment in the firm. Remember that, according to the constant dividend growth model introduced in Chapter 7, the value of common stock can be computed as P 0 5 D / 1 /(r s 2 g). This equation shows that if the firm adopts a policy of paying out more cash dividends, D / 1 rises, which tends to increase the price of the stock. However, everything else equal, if cash dividends are increased, less money is available for reinvestment in the firm and the expected future growth rate, g, will be lowered, which will depress the price of the stock. Thus, changing the dividend has two opposing effects. The optimal Dividend Policy is the one that strikes a balance between current dividends and future growth to maximize the firm’s stock price. In Chapter 12, we discussed concepts related to determining a firm’s optimal capital structure.

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  eBook - ePub

  International Tax Coordination

  An Interdisciplinary Perspective on Virtues and Pitfalls

  • Martin Zagler(Author)
  • 2010(Publication Date)
  • Taylor & Francis

    (Publisher)

  5 Intra-firm dividend policies Evidence and explanation

  Christian Bellak and Nadine Wiedermann-Ondrej 1

  Corporate Dividend Policy remains a topic on which researchers have failed to arrive at even a local sense of closure. (Marsh and Merton 1987)

  5.1  Introduction

  Although considerable progress has been made in empirical research over the past 20 years, unexplored territory remains. One such area concerns intra-firm dividend policies in a cross-border setting of firms. In this study, the Dividend Policy of firms is defined as the decision made about the level of dividends (i.e. the payout ratio) and about the adjustment of dividends (i.e. dividend smoothing), with a focus on the latter.

  What is dividend smoothing? “Dividend smoothing implies a deliberate effort on the part of managers to adjust dividend payments in response to variations in the earnings stream” (Bhabra et al . 2002: 166).

  We are interested in particular in explaining intra-firm dividend policies that take the form of intra-firm dividend smoothing. In spite of the fact that these policies constitute an important element in multinational enterprises’ (MNEs) financial policies, empirical evidence is rather scarce (see section 5.2 ).

  The setting for the Dividend Policy decision chosen in this chapter is a German parent company – that is, a German MNE that owns subsidiaries abroad. An MNE may finance its foreign operations through various means (equity, debt, etc.). If the foreign subsidiary is profitable, then the parent company may wish to shift some of the profits home to finance new investment. Obviously, the parent company may also have other options. For example, it may reinvest the profits at the subsidiary where it emerged or at other subsidiaries. However, these options are not the focus of this chapter.

  Furthermore, there are also many options for shifting profits back home from a foreign subsidiary. They include share repurchases, dividend payments, profit shifting via transfer pricing (for example, see Leibrecht and Rixen, this volume, Chapter 4

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  eBook - ePub

  Corporate Finance

  A Practical Approach

  • Michelle R. Clayman, Martin S. Fridson, George H. Troughton(Authors)
  • 2012(Publication Date)
  • Wiley

    (Publisher)
• For the past three years SCII has been making share repurchases, so investors are already cognizant that management is distributing cash to shareholders. The initiation of a dividend as a continuation of that policy is less likely to be interpreted as an information signaling event.
Solution to 2. A stock dividend has no effect on shareholder wealth. A shareholder owns the same percentage of the company and its earnings as it did before the stock dividend. All other things being equal, the price of a stock will decline to reflect the stock dividend, but the decline will be exactly offset by the greater number of shares owned.
Solution to 3. As shown in the Statement of Cash Flows, the $0.40 a share annual dividend reflects a total amount of $15 million, fully using SCII’s free cash flow after acceptance of positive NPV projects. The proposal brought before the board does not suggest a commitment to maintain the annual dividend at $0.40 a share (or greater), as a stable Dividend Policy would typically imply. Rather, the funding of profitable capital projects will first be considered. These facts taken together are most consistent with a residual Dividend Policy.