Evaluating Dividend Policy in action and Theoretically

This paper contains a description of a house ‘s Dividend Policy ; further this paper explains how the pick of dividend policy is proved irrelevant in Modigliani & A ; Miller ‘s theoretical universe. Following this treatment, some grounds are cited as to why and how real-world phenomena do do some dividend policy picks better than the others. Some mention has been made to the fact where the advantage of redemptions over dividends has amplified in the recent old ages.

Executive Summary Report

In recent old ages, U.S corporations have paid out about 40 % of their net income as hard currency dividends. However, a important figure of houses pay no hard currency dividends while many pay dividends in surplus of their net income. Dividend determination is really of import for the corporations, the ground that this determination determines what financess are retained by the house for reinvestment and what financess flow to the investors. Dividend policy can besides supply information to the stock holder refering steadfast public presentation.

However, dividends can non be viewed in isolation. Companies presently devote about 40 per cent of net income to portion redemptions every bit good, a per centum much higher than that of merely a few decennaries ago. Therefore, dividends and redemptions must be seen as alternate pay-outs viing for corporate hard currency flows.

This paper examines corporate policy refering dividends and other pay-outs. Besides it establishes the irrelevancy of any pay-out policy in a universe of perfect capital markets. However, dividends have barely vanished, taking the treatment to a hunt for the benefits of a high dividend policy in the last subdivision of the paper.


Dividend is referred to as a hard currency distribution of net incomes, to the house ‘s stockholders. More by and large, any direct payment by the corporation to the stockholders may be considered as a portion of the dividend policy.

Dividend Policy is defined as the “ The policy a house uses to make up one’s mind how much it will pay out to stockholders in dividends. ” [ 1 ] . In other words, dividend policy helps the houses in taking the right dividend payment options. It besides helps the stockholders to acquire information sing the public presentation of the house.

Why is dividend policy of import? First ground can be, make up one’s minding the sum of net incomes to pay out as dividends is one the major fiscal determinations that a house ‘s finance directors have to face. The 2nd ground is that a good cognition and apprehension of dividend policy is really indispensable for many other countries of fiscal economic sciences.

In peculiar, the theories of plus pricing, capital construction, amalgamations and acquisitions, and capital budgeting all rely on a position of how and why dividends are paid.

Cardinal footings

Date of payment, day of the month of records, declaration day of the month, ex-dividend day of the month, stock dividends.

Purpose of the survey

The chief intent of the paper is to explicate the importance of dividend policy for a house. The paper besides examines the extensively implied steps to cipher the sum a house pays in the dividends.

Does anyone truly pay attending to dividends?

To supply a glance of what the existent universe thinks about the importance of dividends and dividend policy, the followers are some of the extracts from the popular fiscal imperativeness.

Dividend alterations historically are dawdling indicant of corporate profitableness and at the same clip a mark that corporate boards have assurance in the hereafter. Because dividend decrease is seen as a really bad mark, companies hate to raise wage outs to an unsustainable degree. ( New York Times, January 3,1997, Section D, p.4 )

One large disadvantage of larger dividends is that they erode a company ‘s hard currency shock absorber for recessions. Larger dividends and lower hard currency militias besides mean somewhat less confidence to stockholders that the house would be able to refund them in difficult times. ( New York Times, May 17, 1996, Section D, p.1 )

Changes in dividend policy tend to co-occur with the release of other of import intelligence refering the company. Taking into the consideration the illustration of Microsoft, it does n’t pay any dividend because they can bring forth higher returns for stockholders puting their net incomes back in the company.

In a figure of recent surveies, economic experts were non surprised to happen that the portion monetary values of a house that cut dividends underperformed houses that increased dividends in the 12-month period predating the proclamation of the cut. ( Detroit News, August 4, 1996, p.F2 )

These extracts from the popular fiscal imperativeness illustrate that houses ‘ dividend policies so have existent universe relevancy.

Types of dividends

Dividends can be classified in many ways. The basic nature of the type of payment process followed is the footing of sorting dividends in an appropriate mode.

Stock dividends:

In this type of dividend, extra stocks are given out, i.e. increasing the figure of portions outstanding. This may besides include cut downing the monetary value per portion. It is normally expressed as a ratio.

Regular dividends:

This type of dividend is paid in regular intervals, i.e. quarterly, semi-annually. The U.S corporations pay dividends on quarterly footing, while Indian houses pay dividends yearly.

Particular dividends:

These dividends are paid along with the regular dividends.

Neutralizing dividends:

Sometimes houses may besides construe what they show on their books and pay dividends that are extra of the maintained net incomes.

Factors that determine the dividend policy

The factors that help in find the dividend policy of a house may, for the elucidation intent, be classified into:

Dividend Payout Ratio ( D/P )

It can be defined as the per centum portion of the net net incomes distributed to the stockholders as dividends. This ratio is a really of import facet of the dividend policy. It is holds the inclusion of the determination to pay out net incomes or to retain them for future re-investment. The ratio indicates the per centum net incomes distributed to stockholders in hard currency, calculated spliting the hard currency dividend per portion by its net incomes per portion.

Stability of dividends

The stableness of the dividends refers to the consistence or deficiency of variableness in the watercourse of dividends. In simpler footings it is the phenomena of payment of certain minimal sum of dividend regularly.

The Stability of dividends can be seen in these three different signifiers:

Changeless dividend per portion

Harmonizing to this signifier, the house has to pay certain fixed sum per portion as dividend.

Changeless pay-out ratio

Harmonizing to this signifier, the house has to pay a certain fixed per centum of net incomes as dividend to the stockholders.

Changeless dividend per portion plus excess dividend

Harmonizing to this signifier, while traveling through the old ages of pronounced luck ; the house pays excess dividend with the regular dividend. But every bit shortly as the normal conditions return, the house cuts down the excess dividend.

Legal, Contractual, and Internal restraints and Restrictions

These facets besides play a really important function in the dividend determination, because of certain statuary demands, the contractual limitations arise from certain loan compacts and the internal restraints are the consequence of the house ‘s liquidness place.

Owner ‘s Considerations

In this facet the chief purpose of the house is to supply benefit to its stockholders. In other words, the house needs to take a dividend policy that is good to the bulk of the stockholders. The certain common considerations of any stockholder are:

The revenue enhancement position of the proprietor

Their chances of investing

The dilution of ownership

The point to be noted is that it is about impossible to set up a policy that will maximize each proprietor ‘s wealth.

Capital Market Considerations

This aspect trades with extent that a house has entree to the capital markets. There are two consecutive instances:

Easy Access:

The house has an easy entree to the capital market, either it is strong financially or big in size, it can follow a broad dividend policy.

Limited Access ;

The house has a really limited entree to the capital market, and so it is really obvious for the house to take in low dividend pay-out ratios. These houses are likely to be more dependent on maintained net incomes as a beginning of financing their investings.


During the rising prices period the houses tend to maintain low on dividend pay-outs. Inflation is yet another facet that affects the dividend determination, the ground being that the houses have to trust upon the maintained net incomes as a beginning of financess to do up the deficit.

Measures of dividend policy

The dividend policy is measured by and large by a house by the execution of one of the two steps:

Dividend output

The ratio shows the relation between the dividends paid to the monetary value of the stock. It can be defined as the ratio of Annual dividends per portion to monetary value per portion.

The dividend output is of import because it can supply a step of the entire return that comes from dividends.

The investors can utilize this step for the computation of hazard and the investing screen. This means that they are acute in puting in the stocks those have high dividend outputs.

Dividend pay-out ratio

The ratio shows the relation between the dividends paid to the net incomes of the house. The payout ratio can be used in different signifiers besides, for case for gauging dividends in future periods under the rating ; appraisal of houses with high keeping ratios. The last and the most of import use of the payout ratio is that it follows the life rhythm of the house, i.e. all the manner from the house ‘s induction, growing, adulthood.

The Dividend Procedure

The determination to pay a dividend rests in custodies of the board of managers of the corporation. A dividend has to be distributed by the house to its stockholders on a specific day of the month. After the declaration of a dividend it converts into the liability of the house and it is really difficult to be cancelled by the corporation.

The working of the dividend procedure can be illustrated by the undermentioned illustration:

Declaration day of the month:

On January 10, declaration is passed by the board of managers that the house has to pay a dividend of $ 1 per portion on February 12 to all the available holders of record on January 30.

Date of Record ;

A list is prepared by the corporation on January 30 which has all the persons who are believed as the shareholders of this day of the month. Emphasis on the word believed has been made as to mean the fact that the dividend will non be paid to the persons whose presentment of the stock purchase is received by the house after January 30.

Ex-dividend day of the month:

This depends on the efficiency of the securities firm houses as to how efficient they are to advise the corporation by January 30 all the purchases made by the stockholders till January 29.

To take this job the shareholders were entitled by the securities firm houses as to have the dividend if the purchase is made by them three concern yearss before the day of the month of record. January 28 as in our illustration is the 2nd twenty-four hours before this day of the month of record, this day of the month is called ex-dividend day of the month.

Date of payment:

The dividend cheques are mailed to the shareholders on February 12.

Dividend Policy and the Miller/Modigliani Conclusion

In 1961, two future Nobel laureates in economic sciences, Merton Miller and Franco Modigliani ( M & A ; M ) , published a seminal academic paper illustrating that, under certain simplifying premises, a managed dividend policy is irrelevant. In other words, pull offing a dividend payment in surplus of the residuary dividend can non increase stockholder wealth- all dividend policies are tantamount ; no peculiar dividend policy can increase ( or lessening ) stockholders ‘ wealth over an alternate dividend policy.

The dividend policy in an ideal ( M & A ; M ) universe

The ideal universe to which is being referred to here is the universe of M & A ; M on the footing of certain premises. Here, a Modigliani & A ; Miller ( 1961 ) theorem, called M & A ; M II, says that in this ideal universe of M & A ; M

The entire market value of all the assets issued by a house

is independent of the manner hard currency is distributed to the

stockholders ( the dividend policy )

The thought behind this M & A ; M theorem is that the investor, i.e. the shareholder, has the ability to imitate any dividend policy on his ain and hence the house should concentrate on other issues.

Harmonizing to this construct if the investor feels that the dividend is excessively low, he/she can merely sell off the stocks, therefore cut downing his/her retentions in the house at the same clip as he receives more hard currency. The logic seen here is that, comparing the above result with the status that house had paid the dividend, the result is same ; because if the house had paid higher dividend so this would ensue in the lowering of the monetary values of the portions with the same sum as the dividend at the twenty-four hours of dividend payment.

While if the above state of affairs is reversed, i.e. now harmonizing to the investor dividend is excessively big, so he/she can reinvest it in new stocks in the same house. Therefore, in this manner the investor may lose some exposure to the house, as a consequence of the dividend payment at the same clip as his hard currency retentions remain the same ( or are merely somewhat higher ) as/than before the dividend.

The state of affairs discussed above is the theoretical universe of M & A ; M and now in following statement the alterations would be noticed when some of the premises made by M & A ; M are relaxed.

The dividend policy in the existent universe

As harmonizing to the above theorem, the value of the house remains inert to the alterations in the dividend policy, but so why do the houses think twice about their dividend policy. The ground is that while in the presence of real-life-frictions like revenue enhancements, stockholder value can be created by taking out the best dividend policy.

Keeping the conditions such that the dividends and stock redemptions are taxed otherwise, so it ‘s obvious for the house to take the mean of the hard currency wage out that leads to the most advantageous revenue enhancement decrease.

Now this is one difficult determination for the houses, how to differ the revenue enhancements, one method can be by sacking the stock gross revenues net incomes with the old stock gross revenues losingss in a manner dividend income can non. This resulted in the popularity of the stock repurchases that they are repurchased in stead of ordinary dividends.

Firms can ever avoid excessively big dividend payments, when they are spread outing or purchasing other companies. Now what happens in the existent universe imperfectnesss exist such as information dissymmetries, and this leads to the creative activity of value in cut downing the dividend payment for an expanding house. The ground is clear that in order to make hard currency in the hereafter the house needs to convert the capital market that it is responsible ; this requires a hazard premium by the market to impart to it. This is observed as an unneeded cost for the house and it better cut down the dividend payment and utilize the hard currency for its enlargement programs.

Finally, another ground why houses choose a peculiar dividend policy is the signalling consequence of the dividend. The size of the dividend matters a batch in this instance, the lower the size of the dividend it is interpreted as bad intelligence, while on the other manus if size of the dividend is increased it is interpreted as good intelligence. But this is non the whole narrative, the house is every bit usual free to take its dividend policy for many other grounds than the size of the house ‘s net incomes and it is mostly possible for the house, that it decides to maintain the dividend low incase it has many chances of investing in the close hereafter. Therefore, it ‘s non precisely a bad intelligence! Despite all the logical thinking, still the investors go for stableness in the dividend policy and the houses excessively try to maintain the dividend as near to the old 1s as possible in order to non to lose their current investors.

The Dividend Policy Controversy

Even to this twenty-four hours the M & A ; M dividend policy irrelevancy decision is non accepted by all faculty members or fiscal directors. Some strongly believe that a managed dividend policy can hold a positive impact on proprietor ‘s wealth or that portion monetary value will non drop by the full sum of the incremental dividend paid. However, if dividend policy is of import to stockholders, some of M & A ; M ‘s premises must be in mistake.

Market clashs are the key to the relevancy of dividend policy. If these imperfectnesss are undistinguished, or countervailing, the decision that dividend policy is irrelevant under PCM ( Perfect Capital Markets ) may go on to keep.

A cardinal premise in the Miller and Modigliani ( 1961 ) and other “ dividend irrelevancy ” literature is that all nondividend decisions- the house ‘s operating, investing, and other fiscal decisions- are independent of the house ‘s dividend policy.

In pattern, nevertheless, houses seldom sell equity to countervail dividend payments and keep a changeless capital construction. Therefore, in contrast to the dividend irrelevancy premise, dividend policy can impact the value of the house.