Dividend Policy: The harder we look at the dividend image, the more it seems like a mystifier with pieces that merely do n’t suit together
Dividend policy has remained an country of contradictions. Its issues range from being a mystifier Black ( 1976 ) to irrelevance and so relevancy by DeAngelo ( 1996 ) . Other issues discussed are sing dividend payment theories such as the stakeholders ‘ theory, bureau cost, bird in manus false belief and clientele consequence.
Our purpose here is to analyze, whether dividend policy of a company has any impact on wealth of stockholders or non. Another of import point of view is sing the relationship of stockholders ‘ wealth and the value of the house. The market value of portions is the stockholders ‘ wealth and it is straight related to the value of the house. Harmonizing to Keys & A ; Biggs ( 1990 ) rating of house is indispensable to deduce stock monetary value. Therefore in order to analyze the impact of dividend policy on stockholders ‘ wealth, analysis of its impact on house ‘s value is indispensable.
Investors face systematic hazard because of volatile nature of portion monetary value ( Guo, 2002 ) . Investors are risk averse by nature, and the investing volatility is of extreme importance to them, because it measures the exposed hazard. The volatile portion monetary value is of equal importance for investors and companies. Companies realises the fact that investors closely monitors the dividend form, and in the long tally, peril of investing can hold a significant impact on the value of the house ( Hussainy, et.al, 2010 ) .
Share Price and Dividend Policy
Dividend policy is a policy of a house sing the determination of paying a part of net incomes as dividend or retaining them for the intent of reinvestment. It creates a division of gaining between stockholders ‘ payments and sum reinvested in the house. Therefore, it is an of import component in the funding schemes of the house.
In early times, dividend policy is a pick of the house sing payment of hard currency dividend to its stockholders or keeping of net incomes. It focussed on the frequence of dividend payment ( i.e. whether
yearly, semi-annually, etc. ) and the sum of dividend company should pay.
Today, the construct has gone far beyond the old range. It has included issues like distribution of net incomes through portion redemption or particular dividend. Other issues are to place the best manner to better and keep the value of houses ‘ portions in the market, to keep a balance in penchants of taxed and tax-exempt ( comparatively ) investors etc.
Dividend policy has ever remained in the most researched countries of finance. It has remained associated with the rating of portions and issues like bureau jobs.
Dividend policy is at the really nucleus of corporate finance. The cardinal value-relation of
corporate finance is couched in footings of dividends: the value of an all equity house is equal to the
present value of all future dividends. Therefore it is non surprising that in a recent study on
dividend policy, Allen and Michaely ( 1994 ) cite close to 100 articles. Despite this voluminous
literature, a figure of cardinal issues remain unsolved and clear guidelines for an “ optimum payout
policy ” have non emerged.
Share monetary value volatility step hazard and stand for the rate of alteration of portion monetary value for a given clip period. High volatility means high hazard ; therefore greater return in long tally. Investors prefer lesser hazard. The lesser the sum of hazard due to less volatility in portion monetary value, the better the investing ( Kinder, 2002 ) .
The relationship of dividend policy of a house and stockholders wealth has been explored by many research workers. A figure of theories have been presented to explicate the impact of dividend policies on portion monetary values. These theories include irrelevancy theory, the bird-in-hand theory, clientele consequence etc.
Theories of dividend policy
Dividend policy is amongst the most researched and argued countries of finance. Numerous surveies give grounds to this statement. Gordon ( 1959 ) , Modigliani and Miller ( 1961 ) , Bhattacharya ( 1979 ) , DeAngelo et Al ( 1996 ) , and Al-Malkawi ( 2007 ) , all have presented cardinal constructs of dividend policy. Some of the theories of dividend policy are discussed below:
Irrelevance theory of dividend:
Harmonizing to Miller and Modigliani ( 1961 ) , the pick of dividend policy does non count in a perfect capital market, because it does non impact the house ‘s value. In a perfect capital market:
No dealing costs and revenue enhancements exist.
Assetss are absolutely marketable and divisible.
No ordinances to regulate the operation of market exist.
All participants of market are rational and receive costless information at the same time.
Perfect competition exists in all markets
In such market, there is no demand of explicating dividend policy, because by utilizing capital market, investors can set the hard currency flow form.
Bird in manus theory:
Gordon ( 1959 ) and Lintner ( 1962 ) asserts that investor prefer having sum today as hard currency dividend ( bird in manus ) than future sum as capital addition ( two in the shrub ) . Future hard currency flows are unsure, hence, investors give more deserving to dividends so capital additions. This theory assumes that investors do non hold perfect information sing house ‘s profitableness. Besides dividends give positive signal to the investor regarding of future chances of the house. Walter ( 1963 ) , Al-Malkawi ( 2007 ) supports this theory. However, this theory has been criticized widely. Miller and Modigliani ( 1961 ) and Bhatacharya ( 1979 ) criticized the premises of this theory.
Agency cost theory:
bureau cost is the cost of the struggle of involvement that exists between stockholders and direction see Ross et Al ( 2008 ) . This arises when direction act on their behalf instead than on behalf of stockholders who own the house. This could be direct or indirect. Though this is contrary to the premises of Modigliani and Miller ( 1961 ) , who assumed that directors are perfect agents for stockholders and no struggle of involvement exist between them. This is slightly questionable, as the proprietors of the house are different from the direction. Directors are bound to carry on some activities which could be dearly-won to stockholders such as set abouting unprofitable investings that would give inordinate returns to them, and unnecessarily high direction compensation see AlMalkawi ( 2007 ) . These cost are borne by stockholders, therefore stockholders of houses with extra free hard currency flow would necessitate high dividend payment alternatively. Agency cost may besides originate between stockholders and bondholders, while stockholders require more dividends, bondholders require less dividends to stockholders by seting in topographic point debt compact to guarantee handiness of hard currency for their debt refund. Easterbrook ( 1984 ) besides identified two bureau cost ; the cost of monitoring of directors and the cost of hazard antipathy on the portion of directors.
Signing Hypothesis: though Modigliani and Miller ( 1961 ) , assumed that there is perfect cognition about a house by investors and direction, this has been countered by many research workers as direction who look after the house tend to hold more precise and timely information about the house than outside investors. This therefore creates a spread between directors and investors, to bridge this spread, direction usage dividend as a tool to convey private information to stockholders see Al-Malkawi ( 2007 ) . Pettit ( 1972 ) observed the sum of dividend paid seem to transport great information about the chances of a house, this can be evidenced by the motion of portion monetary value. An addition in dividend may be interpreted as good intelligence and brighter chances and frailty versa. But Lintner ( 1956 ) observed that direction are loath to cut down dividend even when there is the demand to make so. And lone addition dividend when it is believed that net incomes have for good increased.
Clientele effects of Dividends theories: investors tend to prefer stocks of companies that satisfy a peculiar demand. This is because investors face different revenue enhancement intervention for dividends and capital additions. And besides face some dealing cost when they trade securities. Modigliani and Miller ( 1961 ) argued that for these cost to be minimised, investors tend towards houses that would give them those coveted benefits. Likewise houses would pull different patronages based on their dividend policies. Though they argued that even though clientele consequence may alter a houses dividend policy, one patronage is every bit good as another, hence dividend policy remains irrelevant. Al-Malkawi ( 2007 ) affirms that houses in their growing phase, which tend to pay lower dividend would pull clientele that desire capital grasp, while those houses in their adulthood phase which pay higher dividends attract clientele that require immediate income in the signifier of dividend. Al-Malkawi ( 2007 ) , grouped the patronages consequence in two, those that are driven by revenue enhancement effects and those driven by dealing cost. He argued that investors that are on high revenue enhancement bracket would prefer houses that pay small or no dividends to acquire wages in the signifier of portion monetary value grasp and frailty versa. Transaction cost induced patronages on the other manus, arises when little investors depend on dividend payments for their demands ; prefer companies who satisfy this demand because they can non afford the high dealing cost in selling securities.
Factors impacting dividend policy:
Impact of liquidness, hazard, life-cycle theory