SEMINAR IN FINANCE (Group A) A132

DIVIDEND POLICY THEORIES AND (EXOGENOUS & ENDOGENOUS VARIABLES)

PREPERED BY: AHMED HASSAN HADI METRIC NO: 815286 PREPERED FOR: ASSOCIATE PROF. NORAFIFAH AHMAD

DIVIDEND POLICY THEORIES Signaling theory A theory that suggests company announcements of an increase in dividend payouts act as an indicator of the firm possessing strong future prospects. The rationale behind dividend signaling models stems from game theory. A manager who has good investment opportunities is more likely to "signal" than one who doesn't because it is in his or her best interest to do so. Over the years the concept that dividend signaling can predict positive future performance has been a hotly contested subject. Many studies have been done to see if the markets reaction to a "signal" is significant enough to support this theory. For the most part, the tests have shown that dividend signaling does occur when companies either increase or decrease the amount of dividends they will be paying out. The theory of dividend signaling is also a key concept used by proponents of inefficient markets. Clientele Effect The theory that a company's stock price will move according to the demands and goals of investors in reaction to a tax, dividend or other policy change affecting the company. The clientele effect assumes that investors are attracted to different company policies, and that when a company's policy changes, investors will adjust their stock holdings accordingly. As a result of this adjustment, the stock price will move. Consider a company that currently pays a high dividend and has attracted clientele whose investment goal is to obtain stock with a high dividend payout. If the company decides to

decrease its dividend, these investors will sell their stock and move to another company that pays a higher dividend. As a result, the company's share price will decline. Bird In Hand theory A theory that suggests that investors prefer dividends from a stock to potential capital gains because of the inherent uncertainty of the latter. Based on the adage that a bird in the hand is worth two in the bush, the bird-in-hand theory states that investors prefer the certainty of dividend payments to the possibility of substantially higher future capital gains. Agency Cost theory Agency theory assumes that large-scale retention of earnings encourages behavior by managers that does not maximize shareholder value. Dividends, then, are a valuable financial tool for these firms because they help avoid asset/capital structures that give managers wide discretion to make value-reducing investments. Residual Dividend Policy This theory holds that firms pay dividends out of earnings that remain after it meets its financing needs. The term residual dividend refers to a method of calculating dividends. A dividend is a payment made by a company to its shareholders. It is essentially a portion of the company's profits that is divided amongst the people who own stock in the company. A residual dividend policy is one where a company uses residual or leftover equity to fund dividend payments. Typically, this method of dividend payment creates volatility in the dividend payments that may be undesirable for some investors.

Exogenous variable An exogenous variable is a factor that is outside of an economic model; it has an impact on the outcome of the model, but changes in the model do not affect it. Put simply, it is something that affects a particular outcome without being controlled by that outcome in return. These variables are sometimes referred to as independent variables, as opposed to dependent or endogenous variables, which are explained by the mathematical relationships in the model. While endogenous variables can be manipulated within the economic model, exogenous ones are generally uncontrollable. One way to better understand this type of variable is to look at a basic economic model, such as that for the supply and demand for a certain good in terms of the quantity demanded and supplied of that good for different price levels. In the basic version of this model, changes in the amount of money the consumer has to spend on the product affects the amount of demand for the good, but the demand curve does not influence the consumer's income. In this particular instance, consumer income is an exogenous variable. Endogenous variable A factor in a causal model or causal system whose value is determined by the states of other variables in the system; contrasted with an exogenous variable. Related but non-equivalent distinctions are those between dependent and independent variables. A factor can be classified as endogenous or exogenous only relative to a specification of a model representing the causal relationships producing the outcome y among a set of causal factors X (x1, x2, , xk) (y = M(X)). A variable xj is said to be endogenous within the causal model M if its value is determined or influenced by one or more of the independent variables X (excluding itself).

A purely endogenous variable is a factor that is entirely determined by the states of other variables in the system. (If a factor is purely endogenous, then in theory we could replace the occurrence of this factor with the functional form representing the composition of xj as a function of X.) In real causal systems, however, there can be a range of endogeneity. Some factors are causally influenced by factors within the system but also by factors not included in the model. So a given factor may be partially endogenous and partially exogenous partially but not wholly determined by the values of other variables in the model.