Dividend is a hard currency payment made by a company to its stockholders. A company ‘s dividend determination has of import deductions for both its investing and funding determinations which would what money should be give to the stockholder and how much money should be kept in the house which may be used in the ulterior old ages.
The dividend determination, which consider the sum of financess retained by the company and the sums to be distributed to the stockholders, is closely linked to both investing and funding determinations. For illustration the company with few undertakings should return the fresh financess to stockholder by the manner of paying more dividends. A company with several suited undertakings that maintains high dividends will hold to fund from external beginnings.
In the recent old ages, the determination what sum to retain and what sum to pay has become an of import corporate determination. The Management should take into history the outlook of the stockholders and the capital market when doing dividend determination.
Theory of Dividend Policy
Waston and Head ( 2007 ) province that there are two chief theories of dividend policy which are as follows:
Dividend Relevance Theory: Lintner ( 1956 ) and Gordon ( 1959 ) claim that ”dividend policy affects the value of a house, because of stockholder prefer dividend to capital addition. The logic of their penchant sing dividend is that divided is certain but non capital addition. So, dividend policy affects the value of a company ” . The premises of Gordon findings are investors are risk averse and uncertainness augments with respect to whether dividend payments would take topographic point in future ” .
Dividend Irrelevance Theory: Miller and Modigliani ( 1961 ) claim that ”value of a house is non influenced by its dividend policy in perfect capital market with some premises ” . The premises which are needed for the perfect market are as follows:
There is no revenue enhancement consequence on dividend and capital addition
There is no dealing cost
All the investors are acting rationally
There is a perfect market
Arguments for and against that a Higher Cash Dividend Payout Increases the Share Price
Arguments in favour of the statement:
Information content: Waston and Head ( 2007 ) reference that ”a higher hard currency dividend payment plays an of import function to supply favourable information to the investors. Higher hard currency dividend indicates that the company ‘s fiscal status is strength.
Reduce Conflict of Interest: Waston and Head ( 2007 ) states that ”management attempts to guarantee their personal benefits, whereas proprietors are concerned about their ain involvement which cause bureau job. Higher dividend payment rate decreases struggle of involvement, because it indicates that agent ( direction ) is making all things for the well-being of the stockholders ” .
Risk free: Gitman ( 1997 ) argues that higher hard currency dividend reduces the uncertainness of stockholders income, so it leads to increase the portion monetary value of a company.
Arguments against the statement:
Deficit of Cash: High hard currency dividend payments cause deficit of hard currency which lead to waive of doing investings in profitable undertakings and it will move as a fuel to cut down the portion monetary value instead than increase.
Increase the Cost of Capital: The given company has to pull off fund from the external beginning which is comparative expensive than maintained net incomes, because of paying higher hard currency dividend, the capableness of the given house decreases to roll up fund from internal beginning i.e. retained net incomes. Therefore, a higher payment of hard currency dividend increases the cost of capital and decreases the portion monetary value.
Hindrance of Growth: A higher payment of hard currency dividend hinders growing of the house through squashing the investing capacity.
Arguments for and against that Divided Payment is Irrelevant to Maximize the Shareholders Wealth
Argument in favor of the statement
Homemade Dividend: Dividend is irrelevant to the maximization of stockholders wealth, because of if the company does non pay dividend, stockholders can go on their regular income through selling some keeping portions which is called homemade dividend.
Profitableness: The market monetary value of portion depends upon the net incomes or profitableness of the house and non the dividend policy of the given house.
Arguments against the statement
The Clientele Effect: There are some differences for the different types of investors which invested in the given stock of the house. Normally, the investors such as Pensioners and Institutional investors expect regular income in order to run into their liabilities. But in instance of affluent investors, they expect capital addition instead than little regular income in the signifier of dividend. So, dividend payment ratio is relevant to alter the portion monetary value.
Information Content: Waston and Head ( 2007 ) reference that ”a higher hard currency dividend payment plays an of import function to supply favourable information to the investors. Higher hard currency dividend indicates that the company ‘s fiscal status is strength.
Reduce Conflict of Interest: Waston and Head ( 2007 ) say that ”management attempts to guarantee their personal benefits, whereas proprietors are concerned about their ain involvement which cause bureau job. Higher dividend payment rate decreases struggle of involvement, because it indicates that agent ( direction ) is making all things for the well-being of the stockholders ” .
Risk free: Gitman ( 2009 ) argues that higher hard currency dividend reduces the uncertainness of stockholders income, so it leads to increase the portion monetary value of a company.
Argument for and against that Dividend payment should be avoided since it reduces Shareholders Wealth
Arguments in favor of the statement
Tax consequence: Stockholders need to pay revenue enhancement on the dividend received on the portions which decreases their net income as a consequence it will diminish wealth.
Decrease of investing in profitable undertakings: Payment of dividend to the stockholders will cut down the chance of the house to put in the profitable undertakings. So, the house should seek to avoid the dividend payment to its stockholders and seek to concentrate on its investing chances.
Argument against the Statement
Information content: Waston and Head ( 2007 ) reference that ”a higher hard currency dividend payment plays an of import function to supply favourable information to the investors. Higher hard currency dividend indicates that the company ‘s fiscal status is strength.
Reduce Conflict of Interest: ( 2007 ) reference that ”management attempts to guarantee their personal benefits, whereas proprietors are concerned about their ain involvement which cause bureau job. Higher dividend payment rate decreases struggle of involvement, because it indicates that agent ( direction ) is making all things for the well-being of the stockholders ” .
Risk free: Gitman ( 2009 ) argues that higher hard currency dividend reduces the uncertainness of stockholders income, so it leads to increase the portion monetary value of a company.
Determinants of Dividend Policy:
Samuels and Brayshaw ( 1995 ) and Weston, Beasely and Brigham ( 1996 ) reference that the undermentioned factors affect the dividend policy:
Constraints on dividend payments: There are some restraints in the dividend payments which includes
Debt contract imposes some limitations because the involvement on debt is to be paid before the dividend and it is the obligatory payment.
The face that the dividend payment should non transcend the retaining gaining which was mentioned in the balance sheet
It is capable to the handiness of the hard currency, because the dividend is paid merely with hard currency.
Investing Opportunities: Company which pays more dividends it will prorogue the chance to put in the new acceptable undertakings which might be selected on the footing of Net present value of the undertaking.
Alternative beginning of capital: When a house privation to raise a capital though either debt or equity it have to incur some cost which is known as Cost of capital. Generally, a house which want to raise money should seek to do the cost of capital low. Normally, the Equity cost of capital and cost of debt capital should be referred as external cost and the maintained net incomes should be mentioned as internal cost. If have retained gaining about, its cost is less when compared to the cost of external cost. If the houses has strong Retained gaining it should non depend upon the net income of house which is non predictable, and you could non curtail your investing chances in new undertakings.
Ownership dilution: If the direction of the company think that they should non let any farther portions by raising through equity capital or they are loath to thin the ownership it should keep big sum of retaining gaining or militias. If the house has big figure sum of militias so it need to raise capital for any future undertakings. Hence, the company which dont like dilution of control should keep sufficient sum of militias or retaining earning and whenever they need they can utilize for the Business.
Consequence of dividend policy: The consequence of dividend policy depend on 4 factors this includes: Stockholder desire for current future income ; the sensed peril of dividends versus capital additions ; the revenue enhancement affect on the capital addition or divided which may depend upon the relevant statues and the information content of dividend.
Distributable net incomes: The companies act stipulated that the dividend should be paid out accrued net realized net income which includes the current net income and the old accrued net income. Because there is no concise definition of the word accumulated net income in the act the Committee of Accounting Bodies issued guidelines on the finding of the realized and the distributable net incomes and the mentioned that the net income is as per the Accounting criterions and Generally accepted accounting rules i.e. , Profit available for distribution should be calculated after supplying accumulated loosed from the old twelvemonth.
Liquid: When the house announces the dividend it should hold sufficient hard currency to pay the dividend otherwise there liquidity place should be strong. Because, the company may bring forth more net income its does non intend that it should hold it hold all the net income realised in footings of hard currency. It may put some financess in Undertakings or investing for returns. So the direction should see the liquidness before proclamation of dividend.
Decision
The dividend policy is the important portion of the direction determination that need to be handled carefully. If they handled decently they need non to worry about the investing determination and fiscal determination.
Harmonizing to the dividend relevancy theory, the dividend policy plays a critical function in custodies of the investors because the incorrect determination might impact the capital construction of the house. We got from the theory that dividend give the signal consequence to the investores and it has a clientele consequence so we cant avoid the payment of dividend. On the other manus if we pay dividend regularly twelvemonth by twelvemonth it will impact the growing of the company and it will make liquidness jobs. Large company like Mcdonals they avoid the dividend in the intial twelvemonth and they will make a Brand name across the universe and later they pay the dividend.