Dividend Policy
Dividend is the distribution of value to shareholders. 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 (Holder et al. 1998). 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 (Pike and Neale, 2009). However, the decision made on the dividend has an impact on the company’s position now and in the future. It also impacts on the preferences of investors and potential investors (Holder et al. 1998).
Dividends are usually distributed in the form of cash (cash dividends) or share (share dividends). When a company distributes a cash dividend, it must have sufficient cash to do so, otherwise a firm will have a cash flow problem (Pike and Neale, 2009). Moreover, profit generated may not be in the form of cash (Pike and Neale, 2009). Therefore, cash flow statement needs to be looked at regularly. For example, a company may have profit of $500 million but the cash only increase by $200 million in a financial year. This is a concern to the management as insufficient cash may mean the company is unable to pay the dividends or will not be able to invest in the future (Pike and Neale, 2009).
The tendencies in cash dividend policy are not only influenced by internal factors such as investment opportunity, profitability and liquidity of companies, but also, influenced by external factors such as tax (Jensen & Johnson, 1995; Jensen and Smith, 1984; Lintner, 1956). Litzenberger and Ramaswamy (1979) highlighted that dividends decrease shareholder wealth. They argued that investors in high taxation prefer shares will low dividend while investors in low taxation prefer shares that pay high dividends (Litzenberger and Ramaswamy, (1979).
According to Gordon (1959) dividends increase shareholders wealth and due to uncertainty it is preferable to capital gains. In contrast, in irrelevance theory, Modigliani and Miller (MM) (1961) argued that if a company distributed high dividends now it may reduce its dividends in the future. Their argument based on earnings retention as a better way for financing investment. As a result, the shareholders may benefit from future investment.
In the US , Canada , UK , Germany , France , and Japan
On the other hand, Allen et al. (2009) and Cornell and Shapiro (1987) suggest that there are interactions between investment and financing decision. Cornell and Shapiro (1987) emphasis on non investor stakeholders such as customers, employees, suppliers, distributors and other stakeholders can influence this interaction between the dividend and investment policies. Therefore, non investor stakeholders and capital suppliers have an impact on a firms’ dividend.
Allen, et al. (2009) highlighted that Interest groups of firms in different society have different influence in corporation decision makings. For example, through a survey, Allen et al. (2009) found that 97 % of Japanese managers, 59 % of German managers, and 60% of French managers addressed employees’ job security is more important than dividends while only 11% of American managers and 10% of British managers have agreed with this conclusion. Therefore, to explore each stakeholder’s role in corporate finance is important for corporate finance decision makings around the world. While the impacts of managers and creditors on dividend policy are well studied, the role of employees in dividend policy across countries remains unrevealed (Allen, et al. 2009).
To sum up, dividend policy is a consequence of interaction between supply and demand of dividends (Allen, et al. 2009). The dividend policy is determined when this interaction reaches its equilibrium point. When this equilibrium point is reached, the powers of various interest groups are also balanced. Therefore, to study dividend policy, it is important to explore the interaction among various interest groups and to examine how that interaction affects supply and demand of dividends (Allen, et al. 2009).
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Reference
Allen, F. E., Carletti, R., and Marquez, R. (2009) ‘Stakeholder Capitalism, Corporate Governance and Firm Value, University of Pennsylvania
Cornell, B. and Shapiro, A.C. (1987)’Corporate Stakeholders and Corporate Finance’, Financial Management, pp. 5-14.
Denis, D. J. and Osoboy, I. (2008) ‘Why do firms pay dividends? International evidence on the determinants of dividend policy’, Journal of Financial Economics, 89, pp. 62– 82
Holder, M. E., Frederick, W., Langhehr, F.W. and Hexter, J. L. (1998) ‘Dividend policy determinants: An investigation of the influences of stakeholders theory’, Journal of Financial Management, 27 (3) pp. 73 -82
Jensen, G. and Johnson, J. (1995). The dynamics of corporate dividend reductions. Financial Management, 24 (4), pp.31-51.
Jensen, M. C. and Smith, C. W. (1984). The theory of corporate finance: A historical overview. New York , NY
Lintner, J. (1956) Distribution of incomes of corporations among dividends, retained earnings and taxes. American Economics Review, 46 (2), pp.97-113.
Litzenberger, R. H. and Ramaswamy, K. (1979) ‘The effect of personal taxes and dividends on capital asset prices’, Journal of Financial Economics, 7 (2), pp.163-95.
Miller, M. H. and Modigliani, F. (1961) ‘Dividend Policy, growth and Valuation of shares’, Journal of Business, 34, (4), pp 411- 433.
Bibliography
Juma’h, A.H. and Pacheco, C. J. O. (2008) ‘The financial factors influencing cash dividend policy: A sample of U.S.
Inter Metro Business Journal, 4, (2) pp. 23-43
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