Notes On Dividend Policy And Its Effect On The Value Of The Firm

Dividend policy theory is closely tied to the work of Miller and Modigliani (1961, hereafter M&M) and their dividend policy irrelevance thesis. M&M demonstrate that under certain assumptions including rational investors and a perfect capital market, the market value of a firm is independent of its dividend policy. In actual market practices however, it has been found that dividend policy does seem to matter, and relaxing one or more of M&M’s perfect capital market assumptions has often formed the basis for the emergence of rival theories of dividend policy. Because of uncertainty of future cash flow, investors will often tend to prefer dividends to retained earnings. As a result, a higher payout ratio will reduce the required rate of return and hence increase the value of the firm (Gordon, 1959).

In practice, dividend policy will be affected by taxes as tax rates for different categories of investors will differ. Also, a firm’s dividend policy is perceived by the financial markets to be a signaling mechanism. A cut back in dividends may signify that the firm perceives tough

In the theory of dividend irrelevance by Modigliani and Miller, the perfect market is the essential condition for dividend policy to be irrelevant toward a firm’s value (Titman, 2001). In the real world, perfect market can be said impossible to achieve. One of the factors that support the perfect market condition is the absence of asymmetric information. Asymmetric information occurs when a party has more information than the other party in a transaction (Investopedia, 2014).

Dividend policy theories seek to illustrate the rationale as well as the arguments that have been put forward in relations

The value of a company’s stock may entice an investor to offer money. Without knowing the proper value of stocks, investors are hard-pressed to find the right time to buy or sell shares; and investors may miss opportunities solely on the stock’s market value (Zacks, n.d.). The following sections shall (1) calculate the Company’s SV based on its dividends*; and (2) discuss both those calculations’ effect on shareholder value* and the Company’s dividend policies.

Some investors (e.g., pension funds and security dealers) are indifferent between $1 of dividends and $1 of capital gains. These investors should be prepared to buy any amount of stock with-dividend as long as the fall-off in price is fractionally less than the dividend. Elton and Gruber’s result suggests that there must be some impediment to such tax arbitrage (e.g., transactions costs or IRS restrictions). But, in that case, it is difficult to interpret their result as indicative of marginal tax rates.

Firms that pay consistent dividends have performed respectively well in the market during the course of the last few years; especially in industries that are considered consumer staples. It is likely that much of this trend can be explained by market uncertainty as well as historically low interest rates that have driven down returns on bonds and CDS. This research will analyze the attractiveness of these investments from different angles to provide insights into why investors are flocking to companies that pay consistent dividends.

Through the extensive use of literature review, the researchers have attempted to answer the following research questions:

The payment of dividends and the issue of shares in return for capital investment are important aspects of company law. As such, there are certain requirements that must be met in order for both shares and dividends to be lawfully issued. These requirements are located within the company’s articles and statute. The Company’s articles “operate as contract between the company and its members” and outline the requirements that the directors must follow in order for a transaction to be lawful.

Whether or not (and the extent to which) dividends would be paid from the earnings of a public limited company depends on the dividend policy adopted by its management. In early corporate finance, dividend policy referred to a corporation’s choice of whether to pay its shareholders a cash dividend or to retain its earnings. The policy also addressed the frequency of such payments of dividends (whether annually, semiannually or quarterly) and how much the company should pay if it decides to do so. The optimum dividend policy of a firm depends on investor’s desire for capital gains as opposed to dividends, their willingness to forgo present dividends for future returns, and their perception of the risk associated with postponement of returns.

Although Jonathan and Peter have been carried out the relationship between the dividend yield and the expected return, there is a general lack of research in the impact of different horizons on the return. This problem is that the correlation between variance horizons and the anticipated return, which is solved by Fama and French through a regression test:

Next we dealt with the literature review. Here all relevant works were reviewed, concentrating on the findings and recommendations of the authors of the works and expressing opinion(s) more especially, the recommendations. Relevant textbooks, journals, magazines and newspapers, websites were reviewed.

Dividend policy has been an issue of interest in financial literature as many theories have been established to estimate weather this effects the overall value of the firm.Dividend policy connotes to the payout policy, which managers pursue in deciding the size and pattern of cash distribution to shareholders over time. Managements’ primary goal is shareholders’ wealth maximization, which translates into maximizing the value of the company as measured by the price of the company’s common stock. This goal can be achieved by giving the shareholders a “fair” payment on their investments. However, the impact of firm’s dividend policy on

After years of theoretical and empirical researches, the association between dividend policy and share price volatility still remains a source of controversy with absence of general consensus regarding that relation, were different studies have shown contradicting results using different models, and sometimes using the same model but on

Kumar (1988) builds a model that explains dividend smoothing - one of the most salient features of dividend policy. Dividends once again signal a firm’s quality (productivity), but, since they are over invested in the firm, managers will try to under invest by underreporting a firms productivity. While there is no fully revealing equilibrium, Kumar shows that firms will tend to cluster around optimal dividend levels. Agency theory suggests that dividends can be used as a means to control a firm’s management. Distributing dividends reduces the free cash