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Dividend Theory

Dividend Theory
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Published Date:05-05-2017
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DIVIDEND THEORIES FINANCIAL MANAGEMENTINTRODUCTION OF DIVIDEND A dividend is a distribution of a portion of acompany’s earning to a class of its shareholders . Dividends can be in the form of cash , stock ,and less commonly, property. Most stable companies offer dividends to shareholders Often the stock price s of these financially secure companies do not move much ,anddividend’s are offered as a a way to entice , reward and retain investors.DEFINITION OF DIVIDEND According to S. M. Saha “Dividend are profits of trading company divided amongst members in proportion to their shares.” According to the Supreme Court of India “Dividend is the proportion of profits of the company which is allocated to the holders of shares in the company.”DECLARATION OF DIVIDEND Need of the Company The financial requirements of the company should be estimated and if there need are more urgent than company can void dividend declaration and keep all profits as retained earnings and plough back in business. Reasonable returns to shareholders Dividends are earnings for shareholders and they expect reasonable earnings from their investments. Therefore company should declare reasonable dividends regularly and if this does not happen then shareholders are disheartened and market prices of shares.DIVIDEND AND ITS VARIOUS FORMS Dividend is distribution of profits earned by a company among its various shareholders. It is also called pay-out ratio. In most cases, dividends are paid in cash; but there may be other forms dividends also. Let us describe each one of them separately.Forms/Types of Dividend • On the basis of Types of Share – Equity Dividend – Preference Dividend – Scrip Dividends – Bonus Share • On the basis of Mode of Payment – Cash Dividend – Stock Dividend – Bond Dividend – Property Dividend – Composite DividendOn the basis of Time of Payment Interim Dividend Regular Dividend Special Dividend Optional DividendDimensions of Dividend Decision • Pay-out Ratio – Funds requirement – Liquidity – Access to external sources of financing – Shareholder preference – Difference in the cost of External Equity and Retained Earnings – Control – Taxes• Stability – Stable dividend payout Ratio – Stable Dividends or Steadily changing DividendsFactors Affecting Dividend Decision • Legal Provisions• Control Factor • Magnitude of earnings• Liquidity Position • Desire of Share holders• Future requirements • Nature of Industry• Agency Costs • Age of the Company• Stage of Business cycle • Taxation Policy• Business RisksDIVIDEND THEORIESDIVIDEND THEORIES Relationship between Dividend and Value of the Company. A company's dividend policy has the effect of dividing the company's disposable profit into two categories:  Funds to finance long-term growth and  Funds to be distributed to the shareholders.The company may adopt two possible viewpoints on the decision to pay dividends. As a Long-term Financing Decision : With this approach all the disposable profits can be viewed as source of long-term financing. The declaration of cash dividends reduces the amount of funds available to finance the growth and either restricts growth or forces the company to find other sources of financing. Thus, company might accept a guideline to retain earnings as long as either of the following two conditions exists: 1. Sufficient profitable projects are available 2. Capital structure needs equity fundsAs a Maximization of Wealth Decisions: • With this approach, the company recognizes that the payment of dividends has a strong influence on the market price of the equity shares. High dividends increase the value of shares to many investors. • Similarly, low dividends decrease the perceived value of the equity shares. Company must declare sufficient dividends to meet the expectations of investors and shareholders.Dividend Theories Relevance Theories Irrelevance Theories (i.e. which consider dividend decision to be (i.e. which consider dividend decision to be relevant as it affects the value of the firm) irrelevant as it does not affects the value of the firm) Modigliani and Miller’s Gordon’s Model Walter’s Model Traditional Approach ModelDividend Decision and Valuation of firms: The value of the firm can be maximized if the shareholders’ wealth is maximized. • One school of thought, dividend decision does not affect the share-holders’ wealth and hence the valuation of the firm. • Other school of thought, dividend decision materially affects the shareholders’ wealth and also the valuation of the firm.Below mentioned are the views of the two schools of thought under two groups: • The Irrelevance concept of Dividend or the Theory of Irrelevance, and • The Relevance concept of Dividend or the Theory of Relevance.Relevance TheoriesRELEVANCE AND IRRELEVANCE DIVIDEND VIEW POINT • Dividend and market price of shares are interrelated. However ,there are two schools of thought : while one school of thought opinions is that the dividend has an impact on the value of the firm, another school argues that the amount of dividend paid has no effect on the valuation of firm. • The first school of thought refers to the relevance of dividend while the other one relates to the irrelevance of dividend. RELEVANCE OF DIVIDEND- Walter and Gordon suggested that shareholders prefer current dividends and hence a positive relationship exists between dividend and market value . The logic put behinds this argument is that investors are generally risk- averse and that they prefer current dividend, attaching lesser importance to future dividends or capital gains.The Relevance Concept or Theory of Relevance: We have two theories: 1. Walter’s Approach 2. Gordon’s Approach