January 10th, 2018
Determinants, Relevance, and Reasons for Payment or non-Payment of Dividends
Factors Influencing Dividend Policy
Various factors are argued to influence the amount that firms pay out to their stockholders as dividends. Some of these are a result of legislation that governs companies’ operations in different countries. In the UK for instance, the general principle at common law is for dividends not to be “paid out of capital even if the memorandum [MoA] or articles [AoA] of a company authorise such payment” (HM Revenue & Customs n.d, p. 1). The effect of such a practice is that firms can only pay dividends out of the profits that have been availed for that purpose – distributable profits. This then implies an obligation for the companies wishing to pay dividend in every financial period to ensure that their operations are profitable.
For public companies in the UK, an additional requirement in accordance with the Companies Act 1985, section 263; is that such companies must “ensure that the net worth of the company is at least equal to the amount of its capital” before distributable profits are paid as dividends (HM Revenue & Customs n.d, p.1). The implication of this rule is that “a public company can only distribute profit if at the time the amount of its net assets [total assets less liabilities], is not less than the aggregate of its called-up share capital and its undistributable reserves” (HM Revenue & Customs n.d, p.1). This rule also applies where the distribution of the dividends would result in the net assets dipping below the said aggregate levels (HM Revenue & Customs n.d). For the evaluation on whether to pay the distributable profits, the undistributable reserves are taken to comprise: the share premium account; the reserve set aside for capital redemption purposes; “the amount by which the company’s accumulated unrealised and uncapitalised profits exceed its accumulated unrealised losses not written off”; and those other reserves prohibited for distribution by a statute and the entity’s MoA. From the legal perspective, the payment of dividends could thus be a factor of profitability and net worth of the company.
In addition to the legal determined factors, other determinants of an entity’s dividend policy have been advanced. Anil and Kapoor (2008), for instance expound on other determinants of dividend policy in addition to profitability in a study of information technology firms in India. Their data analysis model predicts the dividend payout ratio to be determined by earnings (current and anticipated thus profitability); liquidity (cash flows); taxation; market risk (beta) and the growth opportunities [e.g. revenue growth, market to book value, changes in total assets] (Anil & Kapoor 2008, p. 66). In an earlier study of AMEX, NYSE and NASDAQ listed entities, Fama and French (2001) had noted that dividend payers tended to be more profitable, had lower valuable opportunities for growth and were much larger than the firms that never paid dividends [non-payers] (pp. 11-20). Such findings are buttressed in a later study of firms in US, UK, Canada, France, Germany, and Japan; that find out that dividend payers are relatively more profitable and larger than non payers (Denis & Osobov 2008). The study however observes that the association of growth opportunities to the dividend payment differs across the countries evaluated (Denis & Osobov 2008, p. 65).
Other attempts to find out the factors that determine the payment of dividends by various corporations have been through interviewing the management of different firms. Surveys of financial heads in different studies have for instance identified history of dividend payment, earnings levels forecasted, availability of cash to pay dividends, and the desire to stabilize or increase the share price to be some of the reasons considered when recommending dividends to the shareholders (Baker, Farelly, & Edelman 1985; Baker, Saadi, Dutta, et al. 2007). Such an approach of evaluating dividend determinants was however first provided by Lintner (1956). In a survey of corporate managers to comprehend how they arrived at a particular dividend policy for their respective companies; Lintner (1956) identified various determinants of dividend policy. First and the most predominant consideration was that the management expressed their reluctance in changing the dividend policy if such a decision provided a possibility of reversal in the near future (Lintner 1956, p. 99). Such then resulted in a policy where historical dividends were the main determinants of the policy (Lintner 1956). Change in dividend policy was only viewed to arise from reasons that according to Lintner (1956); “had to seem prudent and convincing to officers and directors themselves and had to be of a character which provided strong motivations to management” (p. 100).
A reason noted to befit changes in the historical payout rates is changes in current earnings. Lintner (1956) argues that such changes compelled the management “to distribute part of any substantial increase in earnings to the stockholders in dividends”; or alternatively cut back the dividends in accordance with substantial or constant decline in earnings (Lintner 1956, p. 100-101). Though other concerns and attributes of the company’s position such as restrictive provisions on dividends distributions, debts whose due dates were close, and liquidity of the entity were important considerations in some cases; such cases were identified to be minimal among the sample (5 percent) and not constant from year to year as happened with earnings (Lintner 1956, p. 101). Earnings thus were the main determinant that influenced changes in the dividend payment to arrive at the desired payout ratio (Lintner 1956). Other trends identified by the Lintner (1956) study, though to a minimal extent compared to targeted future payout ratio were observed in two companies. In one of these the dividend policy was informed by a “roughly median market dividend yield among an ad hoc group of growth companies”, while in another company the dividend policy was largely pegged to a dominating management member’s personality (p. 106).
Determinants of dividend policy, as evident from the reviewed literature are thus varied. Some of the determinants however could be arguably be proposed as the entity’s profitability, liquidity of the firm, corporate taxation, growth opportunities, and market risk (Anil & Kapoor 2008; Denis & Osobov 2008; HM Revenue & Customs n.d). Other determinants would be the historical dividends and the desire to stabilize or achieve a target payout ratio (Lintner 1956; Baker, Farelly, & Edelman 1985; Baker, Saadi, Dutta, et al. 2007). Other determinants however would be company specific such as dominant management personality and behavior of the share holders (Lintner 1956; Baker, Powell, & Veit 2002). These inquests into the determinants of dividends have lead to the expansion of research into other aspects such as the relevancy (purpose) of a dividend policy. Go to part 3 here.