You are here: UK Essays » Custom Essays » High Dividend Company

Free Essays - Essays

High Dividend Company

Introduction

1.2 Dividend Controversy

The theory of dividend is least complete and confusion surrounds the dividend decision. It can be because it is the kingpin to investments and financing decision.

Does dividend really matters? Does high dividend shows the growth of company in future? What really dividend conveys? How much should be the dividend or no dividend? Does the value of firm is effect by dividends or change in dividend policy? There can be a long list of questions and no simple answer will gratify these questions.

In MM (1961) theory it argues that dividend is an important facet of firm valuation in the perfect market with some assumptions where as Myron Gordon (1959) contradict on the latter issue and argues that dividends are irrelevant to the firms valuations it supported is with the model so free cash flow where the dividend is not considered for the calculation.

According to Brennan, Michael these two different arguments of MM theory and Myron Gordon leave mind set on doubts and unresolved questions left in a quandary: both authors develop plausible theories from reasonable assumptions, but mystifyingly reach opposing conclusions.1

Many researchers have devised theories and provided empirical evidence regarding the determinants of a firm’s dividend policy. It is well known debated important topic and handling the prominent position. Many researches have proven its importance and the relevance to stakeholders.

Still now it can be seen as complex topic where dividend policy matter remains unsolved. Over few decades various empirical tests suggest contradiction to the existing theories literature and explain different conclusions being biased to the different theories.

Miller-Modigliani theorem says the dividends that a corporation pays do not affect the value of its shares or returns to investor, because the higher the dividend, the less the investor receive in capital appreciation, no matter how the corporation’s business decision turn out. It is also assumed by Peter and Facbozzi that the dividend paid does not influence the corporation’s business decisions. Paying the dividend either reduce the amount of the cash equivalents held by the corporation, or increase the amount of the money raised. 2

Fisher Black (1976, p. 5) said “The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together “the dividend is the unexplained tale which is hard to understand and seems more like unsolved riddle which does not have any end. Black, F. (1976), “The dividend puzzle”, Journal of Portfolio Management, Winter, pp. 5-8.

According to Myers and Brealey (2005) dividend is the top 10 unsolved listed problems in finance. BOOK name

The dividend policy formation falls into the legal restriction and fame work of Country. Statutory restrictions have been imposed by the companies Act and companies Act administrate the declaration, payment of Dividend. Thus these legal provisions of Companies Act govern the corporate dividend decision. The factors of legal, tax and accounting may substantially vary from country to country which could play a major part in influencing the dividend decisions.

According to the Ming at el(2005) Research which was conducted through questionnaire given out to 2723 Dutch consumer panel out of which only 555 response found out that the investors have strong prefer to get the dividends. Strongly, the investor like dividend especially cash dividends to receive over the stock dividend compared to not receiving dividend, not at all.3

Fisher Black stated that the dividends which are taxed will gradually vanish from the market Bierman (1997). Though the issues of the dividend tax in India has been lifted from the hands of the investor during the Union Budget of 1997 and made taxable by the companies.4 Further the tax on dividend will be discussed in detail in chapter 2 and 3.

1.3 What is the Dividend?

Dividends are payments made by a company to its shareholders out of their profit that are either be re-invested in the business called as retained earnings or it can be paid to the shareholders of the company as a dividend. Few companies can keep the portion of their earning and pay the rest as dividend to their shareholders.

Publicly-traded companies usually pay dividends on a fixed schedule, commonly annually, bi-annually or quarterly; however, they may declare a dividend on the specific dates.

Usually, established, profitable companies pay dividends. In conclusion it does not imply that companies which do not pay dividends are not in profits.

If a company thinks that its own growth opportunities are better than investment opportunities available to shareholders elsewhere, the company should keep the profits and reinvest them into the business. For these reasons, few “growth” companies pay dividends. Though some big companies can retain their profit and do not give dividends for the future funding and contingencies.5 In recent years, the retention of earnings has been a major source of equity financing for private industry and makes harder to define the dividend amount for the shareholders.6

Some companies pay low dividend because management is optimistic about the firm’s future and wish to retain earnings for expansion. In other case some can pay high dividend to share the profit with the investors or can be a false signalling.

Some practitioners support their argument that stakeholders know importance of dividend policy of a firm. For investors dividends are not only a means of regular income, but also an important contribution in valuation of a firm.

Dividends are paid only from the accumulated profits and not out of capital which reflects that companies which were in loss during few years may still pay dividends, but only up to the point that they have retained profits from previous years. This give the benefit of protection to creditors by putting a barrier in the way of shareholders looking to remove funds from the firm, and thereby withdrawing the cushion of capital originally provided by shareholders. More limitation can be position on the dividend freedom by placing restriction in bond, preference and bank loans agreements.

Dividend policy

Dividend Policy is the companies’ usual performance which decides how much the dividend is paid. It is a very important decision in a company, sometime the dividend policy can be openly stated, so the shareholders may conclude the investment decision from the past performance which behaves as signal to the investors. Dividend policy and its impact can be found at the main theory of the corporate Finance in the literature.

According to the Arnold (1998) “The aim of a dividend policy should be to maximize shareholders’ wealth which depends on capital gains and dividends, maximizing the wealth can be understand as “maximizing purchasing power, the way in which an company enables to its stakeholders to indulge in the satisfaction of purchasing and consumption is by paying them dividend”.

As dividend policy is inconsistent with wealth maximization of the shareholder, is better explained by the sum up addition of a socioeconomic behaviour paradigm into economic models. Dividend payouts can also be viewed as the socioeconomic impact of corporate evolution where the information asymmetries between managers and shareholders as dividends increase the attractiveness of equity issue. (Frankfurter and Lane, 1992).

1.3(a) Importance of date in Dividend formation

A dividend is distributed to shareholders of record on specific dates which is decided under the Board of directors of a company. There are main four important dates. When a dividend has been declared, it becomes a debt of the firm and can not be rescinded.

Introduction to Corporate Finance Laurence Booth W. Sean Cleary

1. Declaration date: It is the date on which company’s directors meet to announce the date and amount of the next dividend payment and also called announcement date. Once the payment has been authorized it is called a declared dividend.

2. Ex-dividend date: It is the date on which the broker is permitted to keep share of stock and all the pending transaction have been completed by this date. It has an important date for investors, if he does not own the stock before the ex-dividend date he will not be eligible for the dividend payout.

Furthermore the exchange reduce the price of the stock to the amount of the difference to the dividend it is done because a dividend payout automatically reduces the value of the company's cash-reserves, and the investor would have to absorb that reduction in value because neither the buyer nor the seller are eligible for the dividend it is also called reinvestment date.8

It is important to isolate who receives the dividend due to the stock price reaction following the payment. The stock should fall by the amount of the dividend with no taxes.

The shortened settlement cycle requires that the payment of funds and the delivery of securities take place on the third business day after the trade date. This will reduce credit, market and liquidity risks by decreasing post-trade settlement exposure.

For example under NYSE rules shares are traded as ex-dividend on and after the fourth business day before the record date.

• Before ex date: Dividend = 0

Price = P + D

• After ex date: Dividend = D

Price = P

9

3. Holder-of-record date: After the ex-dividend date on the close of the business the company closes its stock transfer books and makes up a list of the shareholders to date on the holder-of-record date. These shareholders will receive the dividends. There should be generally no price effect on this date.

4. Payment date: The final stage is the delivery of dividend payments to the shareholder on the specified. Though in most cases the payment date is assigned, within two to three weeks after the holder-of-record date and it can been seen as one of the most important date for the shareholders. There should be no price impact on this day either.

1.3(b) Measure of Dividend policy the amount of the dividend is expressed as

There are various methods to measure the dividends, the commonly used are:

• Dividend per share

Dividend per share (DPS) is defined as a simple and intuitive number. It is the quantity of the dividend that shareholders have or receive, over a year, for each share they possess.

DPS = total dividends paid ÷number of shares in issue

The numbers of shares are normally determined by a weighted average of shares remaining over the reporting period of time.

• Dividend yield

The dividend yield is defined as the dividend per share divided by the price per share. The dividend yield on a company stock is the annual dividend payments of the company divided by its Market capitalisation. Numerically it's often expressed as:

Dividend yield (%) = (Gross dividend per share x 100) / Share price

Traditionally, a high dividend yield is believed as a considerable thing among the investors. A high dividend yield is believe to be the confirmation that a stock is under priced, On the other hand , a low dividend yield shows that the stock is overpriced.

“The persistent historic low in the Dow Jones dividend yield during the early 21st century is considered by some bearish investors as indicative that the market is still overvalued, while others talk of a new paradigm of prosperity that renders traditional yield analysis obsolete”.10

• Dividend payout ratio.

The dividend payout ratio is defined as the percentage of a company's net income that is returned to shareholders in the form of dividends also described as Payout Ratio. Numerically it can be expressed as:

Total Annual Dividends Per Share / Diluted Earnings Per Share

Or

Dividends / net income

There are certain factors that affect the dividend payout ratios.

For example, by using different accounting methods yield we get different earnings per share figures that in return, affect the ratio. In addition, businesses on their different growth stages may have different dividend policies. Newly established, fast-growing enterprises typically focused on reinvest their earnings in order to grow their business and enterprises. As such, they normally spot low (or even no or zero) dividend payout ratios Simultaneously, big enterprises, more-established companies able to afford to return a larger percentage of earnings or profits to their stockholders.11

1.3(c) A way to calculate value of a company

Dividends can give investors a sense of what a company is really worth. The dividend discounted model is a classic formula that explains the underlying value of a share, and it is a staple of the capital asset pricing model which, in turn, is the basis of corporate finance theory. According to the model, a share is worth the sum of all its prospective dividend payments, 'discounted back' to their net present value. As dividends are a form of cash flow to the investor, they are an important reflection of a company value.

It is important to note also that stocks with dividends are less likely to reach unsustainable values. Investors have long known that dividends put a ceiling on market declines.12

1.3(d) Types of dividends payments to shareholders

Cash

Cash dividends (most common) are those paid out in form of real cash. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company.

Stock

Stock or scrip dividends are those paid out in form of additional stock shares of the issuing corporation, or other corporation (e.g., its subsidiary corporation). They are usually issued in proportion to shares owned (e.g., for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). This is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization or the total value of the shares held.

Property

Property dividends or dividends in specie (Latin for "in kind") are those paid out in form of assets from the issuing corporation or another corporation, such as a subsidiary corporation. They are relatively rare and most frequently are securities of other companies owned by the issuer; however they can take other forms, e.g. products or services provided by the corporation.

Other

Dividends can be used in the structured Finance. Financial assets with a known market value can be distributed as dividends; though warrants are distributed sometimes in this way. For large companies with subsidiaries, dividend can take the form of shares in a subsidiary company. A common technique for “spinning off” a company from its parent is to distribute shares in the new company to the old company’s shareholder. The new shares can then be traded independently.13

1.4 Importance of dividend: Managers and Investors

According to Angelio(2006) investors point of view is changing against dividend, more importance is given to capital gains than dividends continuum. There is a dynamic increase in the price of stock, especially the firms with stock which do not pay dividends, prevent calculating price values on the constant growth dividend model. 14

The elasticity of investing money in the project also depends on the amount of dividend given out to the shareholder as manager can have fewer internal funds available for future investment as more dividends means less accumulative in-house cash.

Lenders may also have interest in the amount of dividend a firm declares, as more the dividend paid less would be the amount available for servicing and redemption of their claims.

Although according to the MM (1961) investors may be indifferent to the value of the dividend in the perfect world as dividends has no sway on the firm valuation. Any investor can generate home made dividends if needed and can also carry forward the dividend payment in the additional shares when company makes dividend payment.

In a similar situation, manager can be uninterested as funds would be available or could be elevate with out any floatation costs for all positive NPV assignments. Though in real world is important especially in the relation with the tax behavior of dividend and capital gains. It is very common that the dividend is taxed at the higher rate bracket than capital gain which means that it can have negative consequence for investors.

As well as price of raising fund is not irrelevant and can direct to the lower payout during when the positive NPV projects are accessible. Other than the flotation cost there can be information irregularity between investors and the managers which may also have inference for dividend policy.

Myers and Majluf (1984)23 suggested that mangers in many cases favor retained earnings to debt and debt to equity flotation to invest in the present projects. In the same context Jensen and Meckling (1976) 24said that information asymmetry between manager and outside shareholders may follow the agency cost. The method of diminishing the disinvestment of outside shareholders by agents is the promotion of high payout, as high payout will give reduction in cash flow and this the empire building efforts manager as a result.

In the year 1985, Miller and Rock 25 agreed that existence of information lop- sidedness leads to manager’s action of signaling their ability to create higher earnings in future with help of high dividend value. Whereas high payout results in the decline of free cash flow, especially when company needs more investment for the future growth opportunities.

There are many factors which examine the importance of payout depending on the agency cost of outside ownership, flotation cost of external funding and financing restrictions and investor see the payout as the return on the investment in brief. There have been several theories justifying that why companies pay dividend to shareholder and how it affect the investors.

The dividend is generally classified mode of signaling, Clienteles payment, irrelevance to the investors there are also some other definition can be found in the finance books.

Lot of theoretical and empirical work has been done on the dividend topic and most examining dividend relation with the share price or tax preference. India is an important developing economic country and stepping in the world of competition. If we refer back to the past there has not been much of research done on Indian Dividend. In this research the focus is on the determinants of dividend policy in India.

The objective of this essay is to examine the dividend factors affecting the dividend policy of Indian Companies. There will be no analysis of the environment and no share price will be examined. The companies are dividend in two groups, which are regulated and unregulated companies. The main idea of this essay is to find out whether the determinants of dividend policies are different between these two groups.

There has been much research done on the unregulated companies, excluding the regulated companies from their analysis. One of the most recent works is done by I.M. Pandey and Ramesh Bhat (2007) on Dividend behavior of Indian companies under monetary policy restrictions, no difference between the regulated and unregulated dividend policy has been recognized. 15

In this research several financial variables will be used to explain the possible differences in the dividend policy of both regulated and unregulated companies. A cross sectional least square regression method will be used to obtained and analyze the result.

The rest of the paper proceeds as follows. In the next chapter i.e. chapter 2 the Indian Economy will be presented, followed by the literature review of dividend policy in chapter 3.It contains the most of the relevant research done on dividend policy. Chapter 4 discusses the theories of dividend policy.

This is necessary for the understanding of dividend determinants that is why there are such determinants? Chapter 5 explains the dividend determinants. Chapter 6 is the methodology, data description and limitation. It describes and discusses the methodology, simply and variable used for this essay. Chapter 7 is the empirical results. It documents the results of the empirical analysis of the determinants of dividend policy and chapter 8 is the conclusion of the empirical analysis with directions for further research.

All of the essays in the free essays section were written by students and then submitted to us to display and help others. Thanks to all the students who have submitted their essays to us. You should not hand in our essays as your own. We do not condone plagiarism! If you need custom essay help, then have a look at our essay writing services.

Sign up and be the first to receive our latest offers: