Posted at 12.14.2018
Dividend is a cash payment made by a corporation to its shareholders. A company's dividend decision has important implications for both its investment and funding decisions which would what money should be give to the shareholder and how much money should be retained in the firm which might be found in the old age.
The dividend decision, which consider the amount of funds retained by the business and the sums to be allocated to the shareholders, is carefully associated with both investment and funding decisions. Including the company with few jobs should give back the unused cash to shareholder by the way of paying more dividends. An organization with several suited tasks that maintains high dividends will have to fund from exterior sources.
In the recent years, the decision what total retain and what amount to pay is becoming an important commercial decision. The Management should take into account the expectation of the shareholders and the capital market when coming up with dividend decision.
Waston and Brain ( 2007) state that there are two main ideas of dividend insurance plan which are as follows:
Dividend Relevance Theory: Lintner (1956) and Gordon (1959) declare that ''dividend policy affects the value of a company, because of shareholder prefer dividend to capital gain. The reasoning of their preference regarding dividend is the fact that divided is for certain however, not capital gain. So, dividend insurance plan affects the worthiness of your company''. The assumptions of Gordon findings are traders are risk averse and uncertainty augments with regard to whether dividend payments would happen in future''.
Dividend Irrelevance Theory: Miller and Modigliani (1961) claim that ''value of a firm is not influenced by its dividend insurance plan in perfect capital market with some assumptions''. The assumptions that are necessary for the perfect market are as follows:
There is not any tax influence on dividend and capital gain
There is no transaction cost
All the investors are behaving rationally
There is a perfect market
Information content: Waston and Mind (2007) mention that ''a higher cash dividend payment takes on an important role to provide favorable information to the shareholders. Higher cash dividend indicates that the business's financial condition is strength.
Reduce Conflict of Interest: Waston and Head ( 2007) states that ''management attempts to ensure their personal benefits, whereas owners are concerned about their own interest which cause agency problem. Higher dividend repayment rate decreases turmoil of interest, since it indicates that agent (management) does all things for the wellbeing of the shareholders''.
Risk free: Gitman (1997) argues that higher cash dividend reduces the doubt of shareholders income, so that it leads to raise the share price of an company.
Shortage of Cash: High cash dividend payments cause shortage of cash which lead to forgo of earning investment funds in profitable projects and it'll become a fuel to lessen the talk about price rather than increase.
Increase the Cost of Capital: The given company has to manage account from the external source which is comparative expensive than retained income, because of paying higher cash dividend, the capability of the given company decreases to gather fund from inside source i. e. retained earnings. Therefore, a higher repayment of cash dividend heightens the cost of capital and decreases the show price.
Hindrance of Growth: A higher payment of cash dividend hinders expansion of the organization through squeezing the investment capacity.
Homemade Dividend: Dividend is irrelevant to the maximization of shareholders wealth, because of if the business will not pay dividend, shareholders can continue their regular income through selling some holding stocks which is called handmade dividend.
Profitability: The marketplace price of show depends upon the wages or profitability of the company rather than the dividend coverage of the given company.
The Clientele Result: There are some differences for the different types of shareholders which committed to the given stock of the company. Normally, the traders such as Pensioners and Institutional traders expect regular income to be able to meet their liabilities. But in case of rich buyers, they expect capital gain rather than small regular income in the form of dividend. So, dividend payment ratio is relevant to change the share price.
Information Content: Waston and Brain ( 2007 ) mention that ''a higher cash dividend repayment performs an important role to provide beneficial information to the investors. Higher cash dividend indicates that the business's financial condition is strength.
Reduce Issue of Interest: Waston and Mind ( 2007 ) say that ''management will try to ensure their personal benefits, whereas owners are concerned about their own interest which cause firm problem. Higher dividend repayment rate decreases conflict of interest, because it indicates that agent (management) does all things for the wellbeing of the shareholders''.
Risk free: Gitman (2009 ) argues that higher cash dividend reduces the doubt of shareholders income, so that it leads to increase the share price of an company.
Tax result: Shareholders need to pay duty on the dividend received on the stocks which diminishes their net gain therefore it will decrease wealth.
Reduction of investment in profitable projects: Payment of dividend to the shareholders will reduce the opportunity of the firm to invest in the profitable tasks. So, the organization should try to avoid the dividend repayment to its shareholders and make an effort to concentrate on its investment opportunities.
Information content: Waston and Mind ( 2007) talk about that ''a higher cash dividend payment performs an important role to provide beneficial information to the traders. Higher cash dividend shows that the business's financial condition is durability.
Reduce Conflict of Interest: ( 2007) refer to that ''management attempts to ensure their personal benefits, whereas owners are worried about their own interest which cause agency problem. Higher dividend payment rate decreases discord of interest, because it indicates that agent (management) does everything for the wellbeing of the shareholders''.
Risk free: Gitman (2009 ) argues that higher cash dividend reduces the doubt of shareholders income, so it leads to raise the share price of a company.
Samuels and Brayshaw (1995) and Weston, Beasely and Brigham (1996) speak about that the following factors affect the dividend insurance plan:
Constraints on dividend obligations : There are some constraints in the dividend repayments which includes
Debt agreement imposes some restrictions because the eye on debt is usually to be paid before the dividend which is the obligatory repayment.
The face that the dividend repayment should not surpass the retaining earning which was mentioned in the balance sheet
It is subject to the option of the money, because the dividend is paid only with cash.
Investment Opportunities: Company which gives more dividends it will postpones the opportunity to invest in the new satisfactory projects which might be selected based on Online present value of the job.
Alternative source of capital: When a firm want to improve a capital though either debts or equity it have to incur some cost which is recognized as Cost of capital. Generally, a firm which want to raise money should try to make the cost of capital low. Normally, the Equity cost of capital and cost of arrears capital should be referred as external cost and the retained cash flow should be pointed out as internal cost. If have retained gaining almost, its cost is less in comparison with the price tag on external cost. If the organizations has strong Retained earning it will not depend after the earnings of company which is not predictable, so you could not limit your investment opportunities in new projects.
Ownership dilution: If the management of the company feel that they shouldn't allow any more shares by bringing up through collateral capital or they are simply hesitant to dilute the possession it should maintain massive amount retaining generating or reserves. In case the firm has large number amount of reserves then it need to raise capital for just about any future projects. Hence, the business which dont like dilution of control should carry sufficient amount of reserves or retaining earning and whenever they need they may use for the business enterprise.
Effect of dividend insurance plan: The effect of dividend policy rely upon 4 factors this includes :Shareholder desire for current future income; the recognized riskiness of dividends versus capital increases; the tax affect on the administrative centre gain or divided which may depend upon the relevant statues and the information content of dividend.
Distributable profits: The firms react stipulated that the dividend should be paid accumulated net came to the realization profit which include the current revenue and the previous accumulated profit. Since there is no concise classification of the term accumulated earnings in the work the Committee of Accounting Physiques issued suggestions on the persistence of the understood and the distributable profits and the brought up that the revenue is really as per the Accounting criteria and Generally accepted accounting key points i. e. , Revenue available for circulation should be computed after providing gathered loosed from the prior year.
Liquidity: Once the firm announces the dividend it should have sufficient cash to pay the dividend in any other case there liquidity position should be strong. Because, the business may create more revenue its does not mean that it should have it have all the earnings realised in conditions of cash. It could invest some cash in Assignments or investment for returns. Therefore the management should think about the liquidity before announcement of dividend.
The dividend coverage is the key area of the management decision that need to be managed carefully. If indeed they handled properly they need not to get worried about the financial commitment and financial decision.
According to the dividend relevance theory, the dividend coverage plays a essential role in hands of the investors because the incorrect decision might have an impact on the capital framework of the company. We acquired from the theory that dividend give the signal impact to the investores and it has a clientele impact so we cant prevent the repayment of dividend. On the other hand if we pay dividend regularly season by year it'll affect the growth of the business and it'll create liquidity problems. Big company like Mcdonals they avoid the dividend in the intial season and they will create a Brand across the world and later they pay the dividend.