Why companies pay dividends Essay

The dividend policy has grown over the years. This may be so that the company projects itself as a less risky share and thus also gaining investors faith. The investors buy its shares and thus increase its demand. This helps to gives positive signals to the investors signalling that the company is stable and can generate earnings steadily. This hypothesis is gains standing from the dividend hypothesis theory.

When a company decides to pay dividends, it has to be careful on how much it will be given to the shareholders. It is of no use to pay shareholders dividends

Since the emergence of the so-called irrelevance theorem by Miller and Modigliani (1961), many corporations are puzzled about why some firms pay dividends while others do not. They were the first to study the effect of dividend policy on the market value of firms by assuming that there are no market imperfections. Miller and Modigliani (1961) proposed that divided policy chosen by a firm has no significant relationship in as far as the market valuation of the firm is concerned. They went further to explain that; the shareholders wealth remains unchanged irrespective of how the firm distributes it income because the firms’ value is rather determined by their investment policies and the earning power of its assets. They further stated that the opportunity to earn abnormal returns in the market does not exist, that is, owners are entitled to the normal market returns adjusted for risk.

The dividends to Kennecott equal to the difference between Carborundum’s net income after adjustment and the profit retention. The methodology Kennecott’s management team used to determine the value of Carborundum to Kennecott was evaluated using an incorrect set of cash flows. First, it subtracted out the profit retention requirements needed to support Carborundum’s growth even though Kennecott would own the full equity in Carborundum, which is incorrect. Second, depending on the method used to value the company, the relevant set of cash flow is needed to be determined, either the free cash flow to the firm or the free cash flow to equity.

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

Because often dividends are perceived as spendable income (some stock holders look at stocks as a source of income as it is easier to get a dividend instead of selling the stocks). Sometimes investment opportunities are low, they reach the limit of their marketplace, so companies decides to distribute cash in the form of dividends. For some companies it is a way of showing that the company is stable financially and can fulfill the commitment of paying out a dividend. Also it is a way for companies to mitigate agency problems when they have excess cash.

The fact that shareholders are taxed twice through this repayment methodology infers that dividends are not their repayment technique of choice. Furthermore, paying out cash reserves through dividends also has the effect of both reducing the company’s assets and also inhibited the company’s ability to fund future growth as Dividends reduce the company’s retained earnings.

Based on the financing needs, as above dividends would be additional stretch on company finances

In general the three-stage approach allows us to add complexity to the standard dividend discount models by enabling changing growth scenarios throughout the forecasting period: an initial period of higher than normal growth, a transition/consolidation period of declining growth and final a period of stable growth. The main assumptions are that the company on which we conduct the calculation study currently is in extraordinary strong growth phase. The time period with the extraordinary strong growth must be strictly defined and eventually be replaced with the declining growth assumption. Lastly, Capital Expenditures and Depreciation are expected to grow at the same rate as revenues. .

Dividends are subjected to higher tax rate compare to capital gain increased due to share buy-back. This discourages shareholders from desire to receive high dividends in place of higher capital gain as share values increase. A comparison is made below between the proposed capital structure and dividend policy.

The dividends that stockholders receive and the value of their stock shares depend on the business’s profit performance. Managers’ jobs depend on living up to the business’s profit goals.

TABLE OF CONTENTSINTRODUCTION3PERFORMANCE OF AVON'S STOCK FROM 1978-19883EVALUATION OF AVON' S FINANCIAL CONDITION IN MID-19885PURPOSE OF THE EXCHANGE OFFER6EVALUATION OF THE TRADE-OFF7REFERENCES10INTRODUCTIONA firm's decisions about dividends are often mixed up with other financing and investment decisions. Some firms pay low dividends because management is optimistic about the firm's future and wishes to retain earnings for expansion. Other firms might finance capital expenditures largely by borrowing. All the above are examples of dividend policies which can be defined more precisely as the trade-off between retaining earnings on the one hand and paying out cash and issuing new shares on the other. In order to understand the dividend

A dividend is a usually distributed in cash form to stock holders of a corporation approved by the board of director. It may also include stock dividend or other forms of payment. A stock dividend represents a distribution of additional shares to common stockholders. Dividends are only cash payments regularly made by corporations to their stockholders.

Once a company makes a profit, they must decide on what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends. Once the company decides on whether to pay dividends, they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets. What they decide depends on the situation of the

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