Does a dividend policy matter?

1588 WordsApr 9, 20147 Pages
INTRODUCTION That report is a detailed review of dividend policy and whether or not could affect the market value of the company. When companies make profits, managers have to decide either to reinvest those profits for the good of company or either they could pay out the owners (shareholders) of the firm in dividends. Once they decide to pay dividends they may possibly establish a permanent dividend policy, which is the set of guidelines a company uses in order to decide how much of its profits it will pay out to shareholders in dividends and that decision depends on the preferences of existing and new investors and the situation of the company now and in the future (Garrison, 1999). There are various limitations that may affect firm’s…show more content…
If a company pays low dividends may face a fall in share price and that is because investors exchange their shares with shares of a different company with higher dividend policy. Under that theory we have Asymmetry of Information, which means that dividend decisions may contain new information for shareholders and that is because managers have more informations about the health of the company than investors. Asymmetry of information arises when capital markets are not perfect and depend on the direction of the dividend change and the difference between the actual dividend and the expected dividend by the market. Lintner & Gordon argues that shareholders are not homogeneous, they have different needs and preferences and the majority of them need a fixed income preferring dividends to capital gains which depends on their personal tax circumstances. A company’s share price is affected downward form the disappointment of its shareholders if there is a significant change in its dividend policy. Lintner and Gordon use a mathematical model, knows as the Dividend Growth Model, to predict the value of ordinary shares through an increasing stream of cash flows. Dividend growth model is the equation:Po=(Do(1+g))/(r-g)=D1/(r-g), where: Po is the current market price of the share, D1 is the dividend at time t1, g the expected future growth rate of dividend, r the required rate of shareholders and Do the current dividend. The model shows the relationship between the

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