Presentation on Dividend Policy

Done by : ANNA MADZVIMBO

AIDEN DZUMBUNU
CAROLINE MTISI
JOYLNE TAFUMA
MOREBLESSING NYAMUDEZA
GEOFREE GOMBWE
DEFINATION
Dividend policy is the set of guidelines a company uses to decide how much of its
earnings it will pay out to shareholders. Some evidence suggests that investors are not
concerned with a company's dividend policy since they can sell a portion of their
portfolio of equities if they want cash. This evidence is called the "dividend irrelevance
theory," and it essentially indicates that an issuance of dividends should have little to
no impact on stock price. That being said, many companies do pay dividends, so let's
look at how they do it.
THEORIES OF DIVIDEND POLICY
DIVIDEND IRRELEVANT THEORY
The residual theory of dividends implies that if the firm cannot invest its earnings
to earn a return that exceeds the cost of capital it should distribute the earnings
by paying dividends to stockholders. This approach suggests that dividends represent
an earnings residual rather than an active decision variable that affects the
firm’s value. Such a view is consistent with the dividend irrelevance theory put
forth by Merton H. Miller and Franco Modigliani (M and M).2 They argue that
the firm’s value is determined solely by the earning power and risk of its assets
(investments) and that the manner in which it splits its earnings stream between
dividends and internally retained (and reinvested) funds does not affect this
value. M and M’s theory suggests that in a perfect world (certainty, no taxes, no
transactions costs, and no other market imperfections), the value of the firm is
unaffected by the distribution of dividends (Gitman, 2010).
RESIDUAL THEORY OF DIVIDENDS
The residual theory of dividends is a school of thought that suggests that the dividend
paid by a firm should be viewed as a residual—the amount left over after all
acceptable investment opportunities have been undertaken. Using this approach,
the firm would treat the dividend decision in three steps, as follows:
Step 1: Determine its optimal level of capital expenditures, which would be the
level that exploits all of a firm’s positive NPV projects
Step 2: Using the optimal capital structure proportions , estimate
the total amount of equity financing needed to support the expenditures
generated in Step 1.
Step 3: Because the cost of retained earnings, is less than the cost of new
common stock, use retained earnings to meet the equity requirement
determined in Step 2. If retained earnings are inadequate to meet this need,
sell new common stock. If the available retained earnings are in excess of
this need, distribute the surplus amount—the residual—as dividends.
Bird-in-the-Hand Theory
The belief, in support of dividend relevance theory, that investors see current
dividends as less risky than future dividends or capital gains.
Modigliani and Miller argued that the bird-in-the-hand theory was a fallacy.
They said that investors who want immediate cash flow from a firm that did not
pay dividends could simply sell off a portion of their shares according to Gitman
(2010).
Catering Theory
A theory that says firms cater to the preferences of investors, initiating or increasing
dividend payments during periods in which high-dividend stocks are particularly
appealing to investors. According to Gitman (2010).
TYPES OF DIVIDEND POLICY

REGULAR DIVIDEND POLICY

STABLE DIVIDEND POLICY
IRREGULAR DIVIDEND POLICY
NO DIVIDEND POLICY
(a) Regular Dividend Policy: Payment of dividend at usual rate is termed as
regular Dividend. The investors such as retired persons, widows, and other
economically weaker persons prefer to get regular dividends. A regular dividend
offer following Advantages.
 It establishes profitable record of company.
 It creates confidence among shareholder.
 It stabilises market value of shares
 It aids in long term financing and renders financing easier.
 The ordinary shareholders view dividends as a source of founds to meet their
day-to-day living expenses.
Regular dividend can be maintained only by companies of long standing and
stable earnings.
(b) Stable Dividend Policy: The term ‘Stability of Dividend’ means consistency or
lack of variability in stream of dividend payments. A stable dividend policy may
be established in any of following three forms.
            (i) Constant Dividend Per Share: Some companies follow a policy of
paying fixed dividend per share irrespective of level of earnings year after year.
Such firms usually create a ‘Reserve for Dividend Equalization’ to enable them
pay fixed dividend even in year when earnings are not sufficient or when there
are losses. A policy of constant dividend per share is most suitable to concerns
whose earnings are expected to remain stable over number of years.
(ii) Constant Pay out ratio: It means payment of fixed percentage of net
earnings as dividends every year. The amount of dividend in such a policy
fluctuates in direct proportion to earnings of company.
The policy of constant pay out is preferred by the firms because it is related to
their ability to pay dividends.
            (iii) Stable rupee Dividend plus extra dividend: Some companies follow a
policy of paying constant low dividend per share plus an extra dividend in the
years of high profit. Such a policy is most suitable to the firm having fluctuating
earnings from year to year.
Advantages of Stable Dividend Policy:  A Stable dividend policy is advantageous
to both investors and company on account of the following:
(a)    It is sign of continued normal operations of company.
(b)   It stabilises market value of shares.
(c)    It creates confidence among investors.
(d)   It improves credit standing and making financing easier.
(e)    It meets requirements of institutional investors who prefer companies with
stable dividends.
(d)   It improves credit standing and making financing easier.
(e)    It meets requirements of institutional investors who prefer companies with
stable dividends.

Dangers of Stable dividend policy

In spite of many advantages, the stable dividend policy suffers from certain
limitations. Once a stable dividend policy is followed by a company, it is not
easier to change it. If stable dividends are not paid to shareholders on any
account including insufficient profits, the financial standing of company in
minds of investors is damaged and they may like to dispose of their holdings. It
adversely affects the market price of shares of the company. And if companies
pays stable dividends in spite of its incapacity it will be suicidal in long run.
( c)  Irregular Dividend Policy:  Some companies follow irregular dividend
payments on account of following:
(a)    Uncertainty of Business.
(b)   Unsuccessful Business operations
(c)    Lack of liquid resources.
(d)   Fear of adverse effects of regular dividend on financial standing of company.
(d) No Dividend Policy: A company may follow a policy of paying no dividends
presently because of its unfavorable working capital position or on account of
requirements of funds for future expansion and growth
FORMS OF DIVIDEND
1.Cash Dividends  refers to the dividend that is distributed to the shareholders
from the earnings of a firm in the form of cash. Then, it is the choice of the
shareholders, either to reinvest the money or to break out. Cash Dividends are
taxable.
2. Stock Dividends- refers to the dividend that is distributed to the shareholders
from the earnings in the form of additionally fully paid shares. In stock dividends,
firm’s cash is conserved. Also, these dividends are not taxable until the shares are
sold.
3. Property Dividend- refers to the dividends that are paid to the shareholders of
the firm in the form of some property. For Example, Firm shipping the products
made by it to the shareholders.
Property dividend is the alternative to cash and stock dividend. These dividends
are taxable at the fair market value of the property.
4. Liquidating Dividend refers to the dividends that are paid to the shareholders
by the firm at the time of partial or fully bankruptcy or while ceasing business
operations. Usually, the shareholder is paid from the firm’s capital base as per the
number of shares the owe. This type of dividend is non-taxable.
5. Scrip Dividend-refers to the dividends that are given to the shareholders by the
firm in the form of promissory notes or certificates in which the firm promises to
pay the shareholders a decided amount after a particular time period. The firm
issues scrip dividends due to the shortage of liquidity. This type of dividend is also
an alternative to cash and stock dividends
 FACTORS CONSIDERED WHEN ESTABLISHING A DIVIDEND POLICY
Age of Company: It also influences dividend decision of company. A nearly established
concern has to limit payment of dividend and retain substantial part of earnings for
financing its future growth while older companies which have established sufficient
reserves can afford to pay liberal dividends.
Legal Constraints :Most states prohibit corporations from paying out as cash dividends
any portion of the firm’s “legal capital,” which is typically measured by the par value of
common stock. Other states define legal capital to include not only the par value of the
common stock but also any paid-in capital in excess of par. These capital impairment
restrictions are generally established to provide a sufficient equity base to protect
creditors’ claims. An example will clarify the differing definitions of capital.
Liquid Resources: The dividend policy of a firm is also influenced by availability of liquid
resources. Although, a firm may have sufficient available profit to declare dividends, yet it
may not be desirable to pay dividend if it does not have sufficient liquid resources. Hence
liquidity position of company is an important consideration in paying dividends. If company
does not have liquid resources, it is better to declare stock dividend i.e. issue of bonus
shares to existing shareholders.
Requirements of Institutional Investors: Dividend policy of a company can be affected by
requirements of institutional investors such as financial institutions, banks, insurance
corporations etc. These investors usually favour a policy of regular payment of cash
dividends and stipulate there own terms with regard to payment of dividend on equity
shares.
Nature of Industry: Nature of Industry to which company is engaged also considerably
affects dividend policy. Certain industries have comparatively steady and stable demand
irrespective of prevailing economic conditions. For example, people used to drink liquor
both in boom as well as in recession. Such firms expect regular earnings and hence follow
consistent dividend policy. On the other hand, if earnings are uncertain, as in the case of
luxury goods conservative policy should be followed. Such firms should retain  a substantial
part of their current earnings during boom period in order to provide funds to pay
adequate dividends in the recession periods. Thus, industries with steady demand of their
products can follow a higher dividend payout ratio while cyclical industries should follow a
lower payout ratio.
Desire and Type of Shareholders: Although, legally, the direction as to whether to declare
dividend or not has been left with BOD, the directors should give importance to desires of
shareholders in declaration of dividends as they are representatives of shareholders.
Investors such as retired persons, widows, and other economically weaker persons view
dividends as source of funds to meet their day-to-day living expenses. To benefit such
investors, the companies should pay regular dividends. On other hand, a
wealthy investor in a high income tax bracket may not benefit by high current dividend
incomes. Such an investor may be interested in lower current dividend and high capital
gains.
Future Financial Requirements: If a company has highly profitable investment
opportunities it can convince the shareholders of need for limitation of dividend to
increase future earnings and stabilizes its financial position. But when profitable
investment appointments do not exist then company may not be justified in retaining
substantial part of its current earnings. Thus, a concern having few internal investment
opportunities should follow high payout ratio as compared to one having more profitable
investment opportunities.
Stability of Dividends: Stability of dividend refers to payment of dividend regularly and
shareholders generally, prefer payment of such regular dividends. Some companies follow a
policy of constant dividend per share while others follow a policy of constant payout ratio
and while there are some other who follow a policy of constant low dividend per share
plus an extra dividend in years of high profits. A policy of constant dividend per share is
most suitable to concerns whose earnings are expected to remain stable over a number of
years or those who have built up sufficient reserves to pay dividends in years of low profits.
The policy of constant payout ratio i.e. paying a fixed percentage of net earnings every year
may be supported by firm because it is related to firms ability to pay dividends. The policy
of constant low dividend per share plus some extra dividend in years of high profits is
suitable to firms having fluctuating earnings from year to year.
Magnitude and Trend of Earnings: The amount and trend of earnings is an important
aspect of dividend policy. It is rather the starting point of the dividend policy. As dividends
can be paid only out of present or past’s years profits, earnings of a company fix the upper
limits on dividends. The dividends should nearly be paid out of current years earnings only
as retained earnings of the previous years become more or less a part of permanent
investment in the business to earn current profits. The past trend of the company’s
earnings should also be kept in consideration while making dividend decision.
Growth: If a firm is having growth plans for near future, it will adopt low DP Ration to
make the funds available for those growth plans for no extra growth. But if a firm doesn’t
have any growth plans for the near future, then it may adopt high Dividend Payout Ratio.
Control: The firm must control the dividend payout ratio. Making Dividend Payout Ration
too low or too high may create the problems for the firm.
If the Dividend Payout Ratio is low, then the firm will accumulate enough cash to expand
the business or for emergency needs, but that make shareholders unhappy.
If the Dividend Payout Ratio is high, then the firm may have to gather funds from outside
resources, debts, from banks, private institutions, etc, that will give rise to the risk factor.
Tax Policy: Dividend policy is also affected in part of tax policy of the government.
Sometimes the government, in order to quicken the pace of capital formation provides
tax incentives to companies retaining large share of their earnings. By levying additional
tax burden on higher dividend pay-out also companies can be induced to plough bach
sizeable earnings.
Market considerations: One of the more recent theories proposed to explain firms’ payout
decisions are called the catering theory. According to the catering theory, investors’
demands for dividends fluctuate over time. For example, during an economic boom
accompanied by a rising stock market, investors may be more attracted to stocks that offer
prospects of large capital gains. When the economy is in recession and the stock market is
falling, investors may prefer the security of a dividend. The catering theory suggests that
firms are more likely to initiate dividend payments or to increase existing payouts when
investors exhibit a strong preference for dividends. Firms cater to the preferences of
investors.
Owner considerations: The firm must establish a policy that has a favourable effect on the
wealth of the majority of owners. One consideration is the tax status of a firm’s owners. If a
firm has a large percentage of wealthy stockholders who have sizable incomes, it may
decide to pay out a lower percentage of its earnings to allow the owners to delay the
payment of taxes until they sell the stock. Because cash dividends are taxed at the same
rate as capital gains (as a result of the 2003 Tax Act), this strategy benefits owners through
the tax deferral rather than as a result of a lower tax rate. Lower-income shareholders,
however, who need dividend income, will prefer a higher payout of earnings.
A second consideration is the owners’ investment opportunities. A firm should not retain
funds for investment in projects yielding lower returns than the owners could obtain from
external investments of equal risk.
ADVANTAGES OF PAYING DIVIDENDS
Paying dividends to investors has several advantages, both for the investors and
the company:
Investor preference for dividends
The investors are more interested in a company that pays stable dividends. This
assures them of a reliable source of earnings, even if the market price of the
share dips.
Stability
Investors prefer companies that have a track record of paying dividends as it
reflects positively on its stability. This indicates predictable earnings to investors
and thus, makes the company a good investment.
Benefits without selling
Investors invested in dividend-paying stocks do not have to sell their shares to
participate in the growth of the stock. They reap the monetary benefits without
selling the stock.
Temporary excess cash
A mature company may not have attractive venues to reinvest the cash or may
have fewer expenses related to R&D and expansion. In such a scenario,
investors prefer that a company distributes the excess cash so that they can
reinvest the money for higher returns.
Information signaling
When a company announces the dividend payments, it gives a strong signal
about the future prospects of the company. Companies can also take advantage
of the additional publicity they get during this time.
DISADVANTAGES OF PAYING DIVIDENDS
Clientele effect
If a dividend-paying company is unable to pay dividends for a certain period of
time, it may result in loss of old clientele who preferred regular dividends. These
investors may sell-off the stock in short term.
Decreased retained earnings
When a company pays dividends, it decreases its retained earnings. Debt
obligations and unexpected expenses can rise if the company does not have
enough cash.
Limits company’s growth paying dividends results in
Paying dividends result in the reduction of usable cash which may limit the
company’s growth. The company will have less money to invest in the business
growth
Logistics
The payment of dividends requires a lot of record-keeping at the company’s
end. The company has to ensure that the right owner of the share receives the
dividend.
CONCLUSION
Since dividends are important for keeping the investors happy, a company
should decide upon the time and the form of dividends diligently. It should also
keep in the mind the advantages and the disadvantages of the dividends before
framing a dividend policy.
REFERENCE

Gitman and Zutter (2010). Principles of Managerial Finance. 13th Edition.