Dividendsare nil but a signifier of payments made by acorporationto itsshareholders. It is the part of net incomes paid out to stockholders. When a company earns aprofit, that money can be put to two utilizations: it can either be re-invested in the concern, or it can be paid to the stockholders as a dividend.
Dividend policy has been an issue of involvement in fiscal industry since Joint Stock Companies came into being. Dividends are by and large defined as a distribution of net incomes in existent assets among the stockholders of the house in proportion to their ownership. Dividend policy connotes to the payout policy, in which directors pursue in make up one’s minding the size and the form of hard currency distribution to stockholders.
In a company, the Managements primary end is stockholders wealth maximization, which translates into maximising the value of the company as measured by the monetary value of the company ‘s common stock. This end can be achieved by giving the stockholders a fair” payment on their investings. However, the impact of house ‘s dividend policy on stockholders wealth is still unsolved.
THEORIES OF DIVIDEND POLICY:
DIVIDEND IRRELEVANCE THEORY
DIVIDEND RELEVANCE THEORY
DIVIDEND IRRELEVACE THEORY:
The dividend irrelevancy theory is based on the house ‘s dividend policy and is independent of the value of its portion monetary value and that the dividend determination is a inactive remainder. The value of the house is besides determined by its investing and funding determinations with an optimum capital construction, and non by its dividend determination. A common dividend policy should be able to function all houses because the dividend policy is irrelevant in finding steadfast value.
Modigliani and miller pointed out that the investors who are rational, may do the pick but maximise their public-service corporation, which are apathetic to having capital additions or dividend on their portions. From the position of maximizing the stockholder public-service corporation is that a company maximises its market value by following an optimum investing policy. Such a policy is represented by a company which invests undertakings that yield a positive net nowadays value and maximises the net present value of the company as a whole. A company with deficient internal financess can raise financess on the capital market, leting it to finance on undertakings.
Hence, harmonizing to Modigliani and Miller, the determination on investing is divorced from the dividend determination. A company ‘s pick of dividend policy, given its investing policy, is truly a pick of funding scheme.
Arguments FOR DIVIDEND IRRELEVANCE: –
A house can non foster to gain in surplus of its cost of the capital invested. The house should administer its gaining to its stockholders in signifier of dividends.
M & A ; M 1961, argue that a houses value is by and large determined by its investing policy and is split in the signifier of financess and dividends are to be reinvested and therefore does non impact the value of a house.
Therefore, from this we get to cognize that at that place has non been flawlessness in understanding the capital markets.
The patronage of a company refers to a individual who has money to put, come in all assortments of penchants, and some with low wage out and some with high wage out demands.
There has besides been an statement in alterations of the dividend policy from low to high payouts.
M & A ; M ( 1961 ) , Black and Scholes argue that all patronages are satisfied, and their demands for low or high payouts will non be affected on the portion monetary value of a company.
There has been a counter statement to this that the monetary values would be affected to the informational content of dividends with future net incomes instead than to the dividend itself.
There has besides been a strong consistence between M & A ; M ( 1961 ) and those of the dividend irrelevancy advocates, and the residuary theory.
DIVIDEND RELEVANCE THEORY:
A theory by Miller and Modigliani that, in a perfect universe, the value of a house is unaffected by the distribution of dividends and therefore, it is determined entirely by the gaining power and hazard of the assets of a company.
Dividend relevancy theory, states that the current dividend payments cut down investor uncertainness and finally consequence in a higher value for the house ‘s portions.
In capital markets, the absence of revenue enhancements and dealing costs, dividend policy is irrelevant because it can non impact the stockholder value. The consequence of any dividend policy can be offset by direction seting the sale of new stock or by investors seting their dividend watercourse through stock purchases or gross revenues.
This was a theory proposed byMyron J. GordonandJohn Lintner. Therefore, Dividendrelevance theorysuggests that investors are generallyrisk averseand would instead havedividends today than possible portion grasp and dividends tomorrow.
Dividend relevancy theory provinces that dividend policy affects theshare monetary value of a company. Therefore, optimum dividend policy should be determined which will guarantee the maximization of the wealth of the stockholders. Empirical surveies do non back up this theory. However, actions of market participants tend to propose that there is some connexion between dividend policy and portion monetary value in a company.
Therefore, when dividends are raised, this is viewed by investors as acknowledgment of future net incomes addition. Therefore, if a house ‘s stock monetary value additions with a dividend addition, the ground may non be investor penchant for dividends, but outlooks of higher future net incomes. A dividend decrease may province that direction may calculate hapless net incomes in the hereafter. Therefore, companies with high dividends will hold a patronage of investors with low fringy revenue enhancement rates and strong desires for current income. And besides, companies with low dividends will pull a patronage with a demand for current income, and who frequently have high fringy revenue enhancement rates.
Arguments FOR DIVIDEND RELEVANCE: –
There has been an statement on dividend policy for so many old ages now, which has in bend resulted in two groups.
A Conservative group believes that higher dividend payouts will ensue in an addition in the value of a company.
On the other manus it besides believes that a high value of dividend will diminish the house ‘s value.
There has besides been an common belief in concern that the net incomes paid out as dividends should be given a much higher multiplier in measuring portions than non to administer net incomes.
It besides argues that there seems to be a natural patronage for portions that have high wage outs because dividends are a expendable income. Whereas capital additions are an extra income to the capital.
Myron J Gordon ( 1959 ) and John Lintner ( 1956 ) have suggested that in the early 1960ss, investors see current dividends as less hazardous than future dividends and capital additions.
One more ground could be that companies may hold plentifulness of free hard currency flow but they may hold merely a few investing chances.
Another major scenario is the consequence of revenue enhancements which is likely to interfere with the dividend irrelevancy.
By and large talking, if dividends are taxed more than capital additions so they are more opportunities to reassign the dividends into capital additions.
Apart from the differentiation between income and capital additions, there has besides been an consequence on differential rates of personal income revenue enhancement and besides there is a possibility that a company may hold stockholders of both private and corporate types, who are by and large taxed under different revenue enhancement conditions.
Dividend payment has negative impact on stockholders wealth:
I ) Arguments for and against of a hard currency dividend payout that would hold an impact on the Market value of a company:
Arguments favoring the impact:
Dividend reduces hard currency flows of a company which leads to diminish the value of the company ‘s capital which would ensue in the addition of stockholders wealth
If a company pays higher hard currency dividend to the stockholders, it gives more mark of opportunities about its hereafter to its investors and the addition in dividends may take straight to an addition in the company ‘s portion monetary value in the market.
Arguments against the impact:
Stockholders have to pay revenue enhancement on their income that they receive in the signifier of dividends form the company, which in bend causes revenue enhancement liability. Besides, high hard currency dividend payout would take to the lessening in the net incomes of a company and would besides take to shortage of hard currency when a company wants to do investings. This may impact the growing of a company.
In other words stockholders would besides put in the stock market when they receive good sum of dividends from the company.
II ) Arguments for and against, whether a hard currency dividend is paid or non is irrelevant in the context of stockholder maximization
Arguments prefering the impact:
Stockholders by and large prefer a regular income from dividends when their money if invested in a company, in instance a company does non declare dividends to its stockholders one of the grounds could be due to an efficient capital market, as the company recognize that their income by selling a portion of their shareholdings are in the signifier of homemade dividends.
The Net net income value ( NPV ) of a company plays a major function when divides are given to its stockholders. Dividends would non needfully be paid to its stockholders as destructing stockholders wealth in the existent universe could rapidly be replaced by holding a new set of portions.
Arguments Against the impact:
Dividends are sticky” because houses are by and large loath to alter dividends ; in peculiar, houses in order to avoid cutting dividends even when net incomes of a company bead.
It is besides argued that the portion monetary values of a company tend to cut down when there is a decrease in the dividend payments.
A internal cost arises from, an agent moving on behalf of a stockholder. Agency costs are besides one of the nucleus jobs such as struggles of involvement between stockholders and direction. Stockholders wish for direction to run the company in a manner that increases stockholder value. But direction may wish to turn the company in ways that maximize their personal power and wealth that may non be in the best involvements of stockholders.
III ) Arguments for and against weather dividend payments should be avoided, as they would take to a lessening in stockholder wealth.
Arguments prefering the impact of stockholders wealth:
The chief impact on the house ‘s dividend policy on its value is an unsolved issue. Miller and Modigliani province that, the dividend policy should non impact the stockholders wealth ” . Dividend irrelevancy is besides supported by the empirical work of Black and Scholes which leads to an statement in the M & A ; M ( 1961 ) , However, Black and Scholes shows the ability of houses to set dividends and to appeal revenue enhancement which included investors and argue that this supply consequence may account for their determination of no relationship between dividends and stock returns.
Arguments against the impact of stockholders wealth:
Since directors have information that outside investors do non hold, dividend policy is a costly-to-replicate vehicle for conveying positive private information to market participants. In line with these statements, of theoretical accounts by Bhattacharya ( 1979 ) and Miller and Rock ( 1985 ) , among others, happen that dividend payments avoided would convey negative information about the company ‘s growing and future hard currency flows.
If a company avoids dividend payment to its investors, stockholders would retreat their investing that they have invested in the company and therefore this would besides hold an negative impact on the stockholders wealth.
FACTORS AFFECTING THE DIVIDEND POLICY OF A COMPANY:
Stability of Net incomes: Every company has an of import bearing on the dividend policy. Company ‘s holding regular net incomes may explicate a more consistent dividend policy than those holding an uneven flow of incomes. This is because they can easy foretell their nest eggs and net incomes.
Liquid of Fundss: Handiness of hard currency flow in a company is besides an of import factor in dividend determinations. A dividend represents a hard currency escape, it mean that greater the financess and the liquidness of the company the better the ability to pay dividend. The liquidness of a steadfast depends on the investing and fiscal determinations of the company which in bend explains growing of enlargement and the method of funding. If hard currency place is weak, stock dividend will be distributed and if hard currency place is good, company can administer the hard currency dividend.
Extent of portion Distribution: Nature of ownership besides affects the dividend determinations in a company. A company is likely to do determinations against the stockholders for the suspension of dividend. On the other manus, a company holding which has a good figure of stockholders are widely distributed and organizing low or average income group, which would in bend face trouble in procuring such acquiescence because they will underscore to administer higher dividend.
Tax Policy: High revenue enhancement reduces the net incomes of the companies and besides the rate of dividend is lowered down. Government levies dividend-tax of distribution of dividend when its beyond a certain bound. This effects the capital formation of a company.
Past dividend Ratess: When a company formulates the Dividend Policy, the managers must maintain in head the dividend paid to the stockholders in past old ages. The current rate should be around the mean past rate. If it has been increased the portions will be subjected to guess. The company should see the dividend policy of the rival administration.
Ability to Borrow: Well established and big houses have better entree to the capital market than the new Companies and may borrow financess from the external beginnings. Such Companies may hold a better dividend pay-out ratio. Where in smaller houses have to depend on their internal beginnings and therefore they will hold to construct up good militias by cut downing the dividend payout ratio if they require any financess.
Policy of Control: Policy of control is another factor where dividends are concerned. If the managers want to hold control on company, they would non wish to add new stockholders and hence, declare a dividend at low rate. Because by adding new stockholders they fear that they would non be any control and recreation of policies of the bing direction. So they prefer to run into the demands through retained net incomes.
Time for Payment of Dividend: Payment of dividend means outflow of hard currency. Therefore a company distributes its dividend to the stockholders its least needed by the company because there are peak times of periods of outgo. Management should be after the payment of dividend in such a mode that there is no hard currency escape at a clip when the project is already in demand of pressing fundss.
Regularity and stableness in Dividend Payment: Dividends should be paid on a regular basis because each investor is interested in the regular payment of dividend. The direction should, in malice of regular payment of dividend, see that the rate of dividend should be all the most changeless. For this intent sometimes companies maintain dividend equalisation Fund.
Dividend policy is concerned with degree of dividends for the stockholders of a company.Since the preparation of the M & A ; M proposition in 1961, fiscal economic experts have been reasoning about whether dividends have any consequence on the long-run market value of the house. The irrelevant dividend theory based on the plants of M and M, states that the value of the house is non affected by its dividend policy and is hence irrelevant in the finding of ordinary portion price.The relevant dividend theory is based on behavioral dividend theoretical accounts and provinces that under existent life market conditions, the value of the house is affect.
The relevant dividend theory by Gordan ( 1959 ) and Linter ( 1956 ) is based on behavioral dividend theoretical accounts and provinces that under existent life market conditions, the value of the house is affected by its dividend policy and is hence relevant in the finding of ordinary portion monetary value. Under market imperfectnesss such as revenue enhancements, dealing cost and imperfect information, houses tend to follow a stable and consistent dividend policy because houses perceive a dividend policy to be of import to stockholders.
Therefore we conclude based on the directions ‘ positions of a company on dividend payments and the consequence on house value. Because the dividend policy is a natural effect of dividend theory being applied, the decisions to this are categorised under the dividend policies, such as the managed dividend policy, and besides there is a effect of the relevant dividend theory and the residuary dividend policy, a effect of the irrelevant dividend theory.