Dividend policy is one of the most important financial policies, not only form the viewpoint of the company, but also from that of the shareholders, the consumers, the workers, regulatory bodies and the Government. For a company, it is a pivotal policy around which other financial policies rotate. Value of the corporate securities depends to a great extent on dividend and, therefore, in deciding upon the financial structure of a company, dividend has to be assigned due consideration.
Once a company makes a profit, the board of directors must decide what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends.
Once a company decides to pay dividends, there should be established a somewhat permanent dividend policy, which would impact on investors and perceptions of the company in the financial markets providing information concerning the firm's performance. The choice of the appropriate dividend policy depends on the preferences of investors and potential investors as well as on the company's capital structure and its future plans.
The board of directors holds a fiduciary position both with regard to the company as well as shareholders. The board of directors must combine the three decisions pertaining to investment, financing and dividends simultaneously as these three decisions are interrelated. Dividend policy decision influences the financing decision of the firm through retained earnings. Financing decision would relate to the amount of funds to be raised from external sources as the investment needs of a firm can be fulfilled by a combination of retained earnings and external financing. Therefore, higher the amount of retained earnings, given the investment needs, lower will be the need for external finance and vice-versa.
[...] Among the OECD countries, the Czech Republic and Iceland offer partial deductions for dividend payments made by companies, but no country allows full deduction. Individual tax relief There are far more countries that offer tax relief to individuals than to corporations. This tax relief can take either a form of the tax credit for taxes paid by corporations, or the lower tax rate on dividends. In the first case individuals can claim the taxes paid by the corporations as a tax credit when computing their own taxes. [...]
[...] As far as the stock price decreases, the current dividend policy could seem not satisfactory. Thus, let's analyze the alternative policy where initial dividend is higher than cash flow. 2nd Case Initial dividends are higher than cash flow Another policy is for Big Star Corporation to pay $22,000 of dividends immediately, which is $22 per share. As the firm's cash flow is only $20,000, the company will probably issue the extra $2,000 of bonds or stock in the current Year0. [...]
[...] Dividend policy decision influences the financing decision of the firm through retained earnings. Financing decision would relate to the amount of funds to be raised from external sources as the investment needs of a firm can be fulfilled by a combination of retained earnings and external financing. Therefore, higher the amount of retained earnings, given the investment needs, lower will be the need for external finance and vice-versa. In the first paragraph of this paper I will explain three basic theories concerning the firm's dividend policy. [...]
[...] Generally, companies announce stock dividend or stock split when things look good, so a stock dividend or a stock split announcement is often taken as a positive signal, and it results in a price increase. In efficient markets, however, there is not always favorable impact on share price. Setting a dividend policy The three theories which we have considered in the first paragraph conflict with one another, so managers get no clear signal from academic theories as to what their dividend payouts should be. [...]
[...] PARAGRAPH II DIVIDEND POLICY IN PRACTICE Confusion of empirical tests and factors that impact dividend policy We have just seen three theories that describe dividend policy from different sides. As to the irrelevance theory any payout is correct; tax preference theory proves that lower payout is better; and bird-in-the-hand theory argues to set higher payouts. But which theory, if any, is correct? Empirical tests have tried to relate stock prices or P/E (price-to- earnings) ratios to dividend payout. If we could find a sample of companies that varied only with respect to their payout policies, then we could plot P/E's and prices against payout, and if the pattern that emerged was like one of those shown in the following graphs, then this would support one of the theories. [...]
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