Dividend Payout Policy|conclusion

The right structure and influence of dividend policy on the value of the entity is a topic that draws diverse and at times opposing propositions. This is in spite of the fact that dividend provides one of the methods that entities use to provide a return to their investors for the resources they provide. This paper thus aimed to evaluate the determinants of dividend policy and reasons for paying dividends as presented in the growing body of dividend literature; thus assess whether there exists any optimal dividend policy.

The reviewed literature identifies various factors that are associated with the dividend policy. Such include profitability, liquidity, taxation, growth opportunities and history of dividend payment. Though such factors seem to be important considerations for dividend payment or non-payment, the real market trends indicate that dividend could be increasingly becoming extinct. Thus the paper explores the reasons for non payment or payment of dividends. In this respect three major schools of thoughts are identified: that which argues the irrelevance of structuring a dividend policy; that which proposes an increase in market value with an increase in dividend payout; and that which relates dividend payout inversely to market value of the firm.

Proponents of the first school argue, on the basis of an ideal (perfect market) environment. The other schools evaluate the effects of market imperfections on the dividend policy. In these latter perspectives then payment or non payment of dividends is advanced on a number of presumption. First is the clientele effect that in the market there would be groups of customers for different payouts that could influence the stock prices. Secondly is a tax-preference reason that would lead to investor preference for low payouts in exchange for lower taxation on capital gains. A third proposal is that investors could prefer high or stable payout rates that decreases the cash available to the management for use in investment options hence checking management excesses. Only prudent investment would be allowed through such perspectives and in that case managers would have to return to the market to secure investment funds thus being subjected to the scrutiny of investment professionals. Investors thus would opt to pay taxation on dividend income, in exchange for the monitoring that the investment community provides. Finally dividend policy could be viewed in terms of informing the investor community of the entity’s state of affairs. Such then would mean that managers can raise the dividend payout to signal higher intrinsic value than what the market reveals. With such widespread opinions into the dividend policy; it is only possible to conclude that there exists no optimal policy that can be universally applied to every organization.

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Appendix

Table: How Different Factors Affect the Dividend Policy

Factor Effect on Dividend policy
Agency costs
  • High Payout – Preference of higher dividend amounts in exchange for monitoring of   management by professional investment society

o managers will seek investment funds by returning to the markets

  • Stable payout – Returns on investment not compromised in favor of un-vetted investment decisions.
Signaling To convey internal information to private investors:

  • High payouts – where it is perceived that the market value of the entity is lower than its intrinsic value
  • Stable payout – indicate sustainable performance hence guaranteed returns for investors i.e. certainty of income.
Tax systems
  • Low payouts – Encourage low payouts when capital gains are taxed at lower rates than dividends.
Growth opportunities
  • Low payouts – Encourage reservation of distributable profits to fund expansion projects that bear the potential of increasing gains in future.
Liquidity
  • Low payouts – Low liquidity promotes low payouts to avoid the risk of net assets plummeting below levels required by law.
  • High payouts – Reduce the amount of cash flows available to the management thus preventing imprudent investments.
Uncertainty
  • High payout – preference of current high rates rather than unguaranteed higher returns in future i.e. bird in hand
Risk
  • Low payouts – risk that having high payouts might could necessitate a cut in future.
  • Stable payout – risk that increases in payout would be reversed in future; Risk that decreases in payout would be perceived negatively by clientele.
Residual theory
  • Fluctuating rates – Cash is channeled to the use with the highest Net Present Value for instance among projects such as investing, distribution to customers and payment of debts.
Clientele preferences
  • High payout – Investors who are risk averse and probably in low income/ tax brackets.
  • Stable payout – Investors preferring a regular income
  • Low payout – patient investors, high incomes hence high tax brackets, no immediate need for cash.

 

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