Professional Documents
Culture Documents
Theories On Dividend Policy2
Theories On Dividend Policy2
Definition:
• Dividend policy is A firm's decisions on how to
distribute (or not distribute) their earnings to
their shareholders.
• In other words, it is a company's stance on
whether it will pay out profits as dividends or
keep them as retained earnings.
• If the company decides to issue dividends, the
policy will outline whether or not the dividends
will be issued on an ongoing basis, or if the
dividend payout will be infrequent.
Why is it important?
• Dividend policy is concerned with financial policies
regarding paying cash dividend in the present or paying
an increased dividend at a later stage.
• Whether to issue dividends and what amount, is
determined mainly on the basis of the company's
inappropriate profit (excess cash) and influenced by
the company's long-term earning power.
• When cash surplus exists and is not needed by the
firm, then management is expected to pay out some or
all of those surplus earnings in the form of cash
dividends or to repurchase the company's stock
through a share buyback program.
Dividend Theories Outline
Dividend Irrelevance Theory
• Much like their work on the capital-structure
irrelevance proposition, Modigliani and Miller also
theorized that, with no taxes or bankruptcy costs,
dividend policy is also irrelevant.
• This is known as the "dividend-irrelevance theory",
indicating that there is no effect from dividends on a
company's capital structure or stock price.
Cont...
• MM's dividend-irrelevance theory says that investors
can affect their return on a stock regardless of the
stock's dividend.
• For example, suppose, from an investor's
perspective, that a company's dividend is too big.
• That investor could then buy more stock with the
dividend that is over the investor's expectations.
Cont...
ASSUMPTION:
• 1.The firm is all equity firm.
• 2.All investment projects are financed by exclusively
retained earnings
• 3.The rate of return firms is constant
• 4.The cost of capital remains constant
• 5.The firm has perpetual life
• 6.There are no corporate taxes.
Conclusion of Gorden's Model
• The conclusion of Gordon’s model are similar to
Walter’s model due to the fact that their sets of
assumptions are similar.
• The market value of P0 increases with retention
ration b, for firms with growth opportunities, i.e.
when r>k.
• The market value of the share P0 increases with
payout ratio (1-b), for declining firms with r<k
• The market value is not affected by the dividend
policy where r =k
Bird-in-the-Hand Theory
• The bird-in-the-hand theory, however, states that
dividends are relevant.
• Remember that total return (k) is equal to dividend
yield plus capital gains.
• Myron Gordon and John Lintner (Gordon/Litner) took
this equation and assumed that k would decrease as a
company's payout increased.
• As such, as a company increases its payout ratio,
investors become concerned that the company's future
capital gains will dissipate since the retained earnings
that the company reinvests into the business will be
less.
Cont...
Reaction of Stock
Prices to Dividend M AKBAR
79 COMPANIES
LISTED ON KSE
. T test and
stock prices to cash
dividends announcements
are insignificant, for stock
1 Announcements and HUMAYUN 2010 Wilcoxon signed dividends are significant and
FROM 2004 TO
Market efficiency in HABIB BAIG rank test for simultaneous for both
2007
Pakistan cash and stock dividend
announcements are
favorable as well. Signaling theory
106
manufacturing
Impact of DPS on Abdulkarim companies listed Results suggest that
2 2014
Common stock Returns Garba on Nigerian stock relationship between DPS
exchange from T test and and ARR is significant and
1991 to 2003 Regression model direct Signaling theory
60 Thai
Results suggest that stock
Impact of dividend companies listed
Thanwarat prices move upward
3 Announcement on 2012 on stock exchange T test Signaling theory
Suwanna significantly after dividend
Stock returns from 2005 to
announcement
2009
Cross sectional
random effect
Findings reveal that the
model / Panel
signaling affect prevails in
Dividend policy and N.J.Dewasiri 93 Firms from least square
the market as high dividend
Stock Price Volatility: y.k. Colombo Stock estimation by
4 2015 leads to increase in Signaling theory
An Error Corrected Weerakoon exchange from Vector Auto
organizational stability and
approach Banda 2004 to 2013 regression model
inverse relationship between
and Grager
DPO and Stock Volatility
causality test
methods.
Bank Dividend Policy Safdar Husain
BANKS listed on Findings reveal that the
and Investment Tahir,
stock impact of investment
Decisions Muhammad Mutliple
5 2015 exchange/data decisions on the firms Balancing Theory
determinants of Rizwan ullah Regression Model
taken from 2004 financing decisions depend
Financing Decision: Sajid
to 2010 on the risk level
Evidence from Pakistan Mehmood
Results suggest that there is
Dividend signalling and
Market Efficiency in
6 Emerging Economy: A
Jitendar
Kumar
20 Companies with an
201 even window of 61
4 days listed on Bombay
.
Garch Model and
not support and significant
impact of dividend
non-parametric increase/decrease along with
Signaling
theory/Divide
nd Irrelavance
study of Indian Stock Sharma Run Test the financial disclousre on
stock exchange Theory
Market share price of listed
companies