Study On The Relevance Of Dividend Policy Finance Essay


Different surveies demonstrate that the inquiry if dividend policy affects house ‘s value has been capable of arguments among research workers and directors for many old ages. The purpose of this essay is to describe the assorted surveies conducted on this dividend mystifier. The chief position outlined in the essay is that dividend payment is influenced by many different factors, such as stockholders ‘ outlooks, revenue enhancement and uncertainness of hard currency flows. These factors are recognized to play a critical function in directors ‘ determinations on dividend payments. The essay moves so to the relevancy of dividend policy, get downing from Miller and Modigliani ( 1961 ) preposition on dividend policy irrelevancy, supported subsequently besides by Black and Scholes ( 1974 ) and Miller and Scholes ( 1978 ) . In contrast to this thought, a research conducted by Ferrely, Baker and Edelman ( 1986 ) showed on a study that directors ‘ position of dividend policy is wholly different, since they consider it as relevant, playing a defined function. Finally the essay focuses on Elton and Gruber ( 1970 ) work on Tax Clientele consequence, which has a high correlativity on dividend policy.


A company ‘s dividend policy is the usual manner companies use when make up one’s minding how large the dividend payment will be. It is the determination, taken by the managers, to pay dividend to stockholders, alternatively of retain financess to put in the house. In other words it is a manner in which companies portion their wealth generated by the concern with stockholders, paying dividend to them, frequently in signifier of hard currency payment. The policy can be publically stated, or investors can infer it from the past dividend payments. In making so, they are likely to do some premises:

Dividend per portion ( the sum of dividend that stockholders will have for each portion they own ) will be maintained at at least the degree of the old twelvemonth.

If the Payout Ratio ( the proportion of net income paid to stockholders as dividends ) followed a changeless way in the yesteryear, the same will be done in the hereafter.

Any form of dividend growing will go on every bit long as the dividend screen ( which shows how many times over the net incomes could hold paid the dividends ) does non fall excessively low.

It is non common for a house to cut dividend payment, since this is frequently seen as an recognition of bad concern ‘ public presentations. On the other manus, increasing dividends is a signal that directors give to investors on the assurance they have on the public presentations of the company.

Following this way, statements against and pro dividends payment are now considered. Some fiscal analysts consider the dividend policy as irrelevant since investors have the ability to make their “ ain dividends ” , i.e. they can reproduce the hard currency flows of different dividend policies by seting their portfolios to their penchants. Another statement against dividend payment considers the revenue enhancement, which on dividend is higher than on capital addition ; back uping this thought is the fact that when a house reinvests financess ( alternatively on paying dividends ) will increase the house ‘s capital and hence the market value of the stock. Traveling back on clip, in 1961 Miller and Modigliani through empirical observation showed in their surveies that dividend policy should no count to the value of the house. We have explained above that fiscal theory is clear on the irrelevancy of dividend policy, while is recognized that in world investors do respond to alterations in dividend policy, since paying dividends send signals to the market, supplying certainty about the company ‘s fiscal stableness. This is because perceptual experience is world: if my company does non pay dividends while all the other companies do, I might believe to travel to another company. A house with a long and stable history of dividend payouts would be positively affected by an addition in dividend, while it would endure from take downing or excluding its distribution. Empirical surveies conducted subsequently by Jose and Stevens ( 1989 ) , Benartzi, Michaely and Thaler ( 1997 p.1032 ) confirmed the authoritative survey by Lintner ( 1956 ) which “ aˆ¦remains the best description of the dividend puting procedure available. ” In Lintner ‘s survey directors realized that stockholders were entitled to a portion of house ‘s gaining through dividends and they believed that stockholders preferred a steady but changeless addition of dividends. They hence sought to do partial accommodations toward a mark payout ratio instead than dramatic alterations which may negatively impact stockholders ‘ outlooks. This theoretical account is such that a alteration in dividend is a map of the mark dividend payout ratio less the last period ‘s dividend payout multiplied by the velocity of an accommodation factor, where the mark dividend payout is a part of the current period ‘s net incomes. Brav et Al ( 2003 ) confirmed Linter ‘s surveies and established that directors tend to stabilise dividends with gradual additions ( when possible ) , set up an appropriate payout ratio and avoid dividend cuts. They besides should put a dividend policy which must be believable to stockholders ( consistent with net incomes and growing of the house ) .

Whenever a company pays dividends, it would utilize one of these three chief attacks: residuary, stableness or loanblend, which is a mix of the two. The residuary method focuses on keeping a balance in the debt/equity ratio since any new undertaking is financed by internal equity. It follows that a company utilizing this attack will make up one’s mind on dividends merely if there is adequate money left over after all the disbursals are met. The stableness is a wholly different attack, which aim is to cut down uncertainness for investors, by taking a cyclical or stable policy that sets dividends at a fixed part of quarterly or annual net incomes. Finally the loanblend method is a combination between the old two. Firms utilizing it view the debt/equity ratio as a short-run end, since they experience concern rhythm fluctuations. As a consequence they normally set a dividend which is a little part of the annual income and that can be easy maintained. Apart from this dividend, houses will offer another excess dividend merely when the income exceeds the mark degree.


Assorted factors are considered to impact the execution of dividend policy.

Stockholders ‘ outlook. Stockholders view dividends as a signal of stable and profitable concern of the house, so they do prefer stable and predictable dividends instead than frequent alterations in them. In absence of bad intelligence from the direction squad, they expect the concern tendency to travel on, at least reflecting general macro economic tendencies. Marsh and Merton ( 1987 ) noticed that most companies tend to supply stable dividends to stockholders as usual pattern, and this leads investors to re-evaluate the value of their portions. Lintner ( 1956 ) finds in his survey that the market puts a premium on dividend ‘s stableness ; for this ground, houses which reach their mark payout ratio are those which used opinions based on factors like: chances for growing of the house and the overall industry, cyclical motions of investings chances and gaining chances for their house.

Following Dempsey et Al ( 1956 ) revenue enhancement is the major ground which could explicate why investors belong to a Clientele: dividends are more to a great extent taxed than capital additions, and this could make what seems to be an inducement for houses to finance more their investings internally and cut down dividend payments. Campbell and Beranek ( 1955 ) observed the diminution of ex-dividend twenty-four hours ( defined by the Internal Revenue Service as “ the first day of the month following the declaration of a dividend on which the purchaser of a stock is non entitled to have the following dividend payment ” ) portion monetary value and compared it with the mean sum of dividend.

Ex-dividend twenty-four hours portion monetary value diminution is less than the sum of dividend paid, and this may explicate that tax-induced dividend patronage exists. Elton and Gruber ( 1970 ) expanded the subject above calculating fringy revenue enhancement rate excessively ; they found out that as dividend output additions, the ex-dividend twenty-four hours monetary value bead increases comparative to the dividend paid. Some old ages subsequently, Miller and Scholes ( 1978 ) argued that the old analysis did non see factors like short-run trading activities and tax-free investors ‘ impact ( like pension financess ) . They said that the positive relation found by Elton and Gruber demonstrates that investors do non necessitate to pay more than the revenue enhancement rate on capital additions on dividend payments. More recent surveies, like Barclay ‘s ( 1987 ) retroflex Elton and Gruber findings. He used a fluctuation of their work to back up the revenue enhancement patronage hypothesis, sing U.S. portions market before and after the U.S. Federal Income Tax execution in 1913. In 2003 the revenue enhancement advantage of capital additions over dividends disappeared, since the same revenue enhancement rate of 15 % is applied to both dividends and long-run capital additions. Despite this, effectual capital additions are taxed at a lower rate, since they are deferrable ( paying revenue enhancement subsequently you have an advantage due to clip value of money ) . As a consequence, houses that pay dividends can be still of lower value.

Bradley et Al ( 1998 ) examined the nexus between cash-flow volatility and dividend payout, separating between agency-cost and dividends ‘ signalling hypothesis. The first, agency-cost theory, says that dividend payout helps cut downing bureau costs. This because, administering dividends, directors have entree to less financess and so can deviate fewer financess to unneeded undertakings which are neither in the involvements of stockholders. They excessively found out that houses with high cash-flow volatility are besides those with the greatest possible bureau costs. Due to the fact that when hard currency flow are volatile investors can non impute those divergences to directors ‘ actions, the higher the expected discrepancy in hard currency flows, the greater are the possible bureau costs and therefore the greater is the trust on dividend distribution. Firms sing unsure hard currency flows should pay higher dividends to investors, as a warrant against unneeded investings by the direction squad. The 2nd, signalling theory, predicts a relation of the opposite mark ; it states that, in a signalling equilibrium, when there is a stockholder wealth punishment associated with a cut in dividends, directors have inducements to avoid these punishments. One manner to make so is to put dividends to a lower degree than the income expected, leting directors to be able to pay dividends even if future hard currency flows are lower than expected. Summarizing up, the two theories lead to opposite decisions. The first provinces that, the higher the volatility of hard currency flows, the higher the dividend payouts should be. The 2nd, alternatively, provinces that the more volatile the hard currency flows are, the lower the dividend payouts will be.


Assorted empirical surveies, such as Black and Scholes ( 1974 ) and Miller and Scholes ( 1978 ) support Miller and Modigliani ( 1961 ) proposition on dividend irrelevancy. However, Ferrelly, Baker and Edelman ( 1986 ) demonstrated on a study that corporate directors believe that dividend policy affects the value of the house and that may be an optimum degree of dividend payout, one which maximizes the house ‘s value. This to state that empirical surveies and directors ‘ existent positions clash on the manner dividend policy is perceived. The four chief accounts offered by research workers on dividend relevancy are now presented.

Bird-in-hand account is based on the statement that dividends are one of the chief drivers of portion monetary value grasp. Since dividends are less hazardous than capital additions, houses should put a high payout ratio and offer a high dividend output to maximise their portion monetary value ( the higher the dividend, the more attractive the portion is. Demand for the portion will increase and therefore house can increase the portion ‘s monetary value they demand ) .

Signing account provinces that dividend policy can be used by houses to pass on information about their hereafter plans to investors. Miller and Modigliani ( 1961 ) noticed in world that a positive alteration in the value of a portion is followed by an addition in dividend payout ratio. As Lintner ( 1956 ) points out, dividend payments can pass on to investors information about directors ‘ appraisal of house ‘s future profitableness, in a manner which other instruments can non. For illustration, before U.S. corporations were required by the Securities and Exchange Act of 1934 to unwrap fiscal information, a company ‘s ability to pay dividends was one of the few marks of its fiscal wellness. Despite this act increased transparence, dividends still remain a cardinal rule of a company ‘s chances. Increasing dividends may be used by directors to cut down informational dissymmetry between them and stockholders. Directors can utilize dividends ‘ positive alterations to indirectly signal private information to outside investors, and to demo that they are confident that the company ‘s net incomes will ever be sufficient to pay dividends ( this because normally directors do non like cutting dividends ) . At the same clip, investors may utilize proclamations by directors to measure house ‘s portion monetary value. John and William ( 1985 ) realized that much empirical illustrations back up this account of dividends as a signalling device.

Agency account is another popular account, once advanced by Jensen and Meckling ( 1976 ) and so extended by Rozeff ( 1982 ) . This theory is derived from the principals-agents struggle of involvements between outside stockholders ( principals ) and directors ( agents ) , in which directors could move non in the best involvement of stockholders, taking to bureau costs. Jensen and Meckling postulated that dividends provide a good manner for directors to cut down those bureau costs coming from their relationship with stockholders. Paying big dividends is a manner to cut down these costs, since they cut down the internal hard currency flow which can be controlled by directors ‘ discretion. In the same manner it forces the house to raise more financess externally, being subjected to the monitoring of outside providers of capital. This besides helps guaranting that directors act in the best involvements of stockholders.

Tax penchant account is the 4th account. Elton and Gruber ( 1970 ) noticed that some investors may favor keeping of financess instead than payment of dividends for tax-related ground ; since capital addition is less taxed than dividends, investors may prefer a low dividend payout to a high 1. As a effect, houses should maintain a low payout ratio if they want to maximise their portion monetary value. Because revenue enhancement is non the same among different type of investors, they may be attracted to houses which have a dividend policy which best suits with their specific revenue enhancement fortunes. This is called by research workers the Tax Clientele consequence. Ceteris paribus, portions with high dividends should pull investors with low or zero revenue enhancement rates, while low dividend payout portions should on the other attract investors with high revenue enhancement brackets.


The determination of directors to pay dividends is influenced by different factors as outlined above, which play an of import function on the dividend policy puting. Dividend payment has an impact on the fiscal side of the house foremost because payment paid means less financess for investing determinations, secondly because having dividends affect stockholders value and the manner they view the house. Of the four chief factors discussed about dividend relevancy, the most of import and agreed among directors is the signalling consequence of dividends, trough which they can positively pass on with investors, impacting their position of the house. Finally, assorted surveies confirmed that directors ‘ positions of dividend payments today are really similar to those of directors interviewed by Lintner in 1956, whose consequences remain still valid presents.