Dividend Payments Impact On Shareholders Wealth Finance Essay

Dividend Payments Impact On Shargonholders Wealth Finance EssayDividendis a form of payment made to sh arholders by an organization Its a profit which is stipendiary out to the caller sh beholders. When a profit is earned by the political party, the profits are used again to endow for a better result of the party for its future, or it can also be gainful to the community shareholders in the form of dividends. Dividends are also nonrecreational to the shareholders in the form of immediate payment or shares. The order must possess fitted pecuniary re seed in order to pay dividends to its shareholders. Dividends are generally paid out by a connection only when the alliance make good profit and its been paid form its earnings.Dividend constitution is of great interest n todays financial industries when the joint stock companies came into existences. Dividends can also be defined as a distri andion of companys earnings which is decided by the board of directors to a class of its shareholders, dividend is also quoted as a percentage of the current market expenditure. It is also know as dividend per share (DPS). Dividend can also be in a form of cash, stock or property.The level of dividends also depends on the companys dividend policy. Many large companies bring on a progressive dividend policy. They are usually paid after half year and full year financial results, even though nearly companies pay quarterly. in that respect are various types of dividends which are as followsCash Dividend Regular Cash Dividend, Special Cash Dividend, Stock Dividend Stock RepurchaseCash dividend When a company pays dividend in the form of cash is known as cash dividend, cash dividends are generally paid four times a years to its shareholders. Such as Regular cash dividends and surplus cash dividends.THEORIES OF DIVIDEND POLICYDIVIDEND RELEVANCE THEORYDIVIDEND IRRELEVANCE THEORYDIVIDEND RELEVANCE THEORYThis was a theory proposed byMyron J. Gordon(1959)andJohn Linte r(1956). in that respectfore, Dividendrelevance theorysuggests that investors are taking a risk generallyand would rather havedividends today rather than share appreciation and dividends tomorrow. Myron J Gordon(1959) and John Lintner (1956) have also suggested that in the early sixties, investors see current dividends as less risky than future dividends and swell gainsDividend relevance theory also states that dividend policy effects theshare price of a company. Therefore, an optimal dividend policy should be determined which get out ensure the better wealth of the shareholders. However some market participants state that there is some connection between share price and the dividend policy of a company.DIVIDEND IRRELEVACE THEORYAccording to Modigliani and Miller (1961) the dividend policy is irrelevant to the share price of the company. The value of the self-colored is determined by the earning capacity of a company and non by its dividend decision.Modigliani and Miller (1961) pointed out that the investors who are rational may make the choice but maximise their utility, which are indifferent to receiving capital gains or dividend on their shares.The assumption of this theory states thatThere are no transaction cost on the buy and selling of the sharesInvestors are having sufficient knowledge about the companyTaxes are ignoredSame interest rate would be available to investorsAccording to the preceding(prenominal) assumption, the company which has good prospective with a positive NPV will have a good share price in the market.Dividend payment has impact on shareholders wealthArguments for and against of a cash dividend payout that would have an impact on the Market value of a companyArguments in favour of the impactSignalling effectIf a company pays dividend to its shareholders regularly, it conveys a message to its investors showing the current growth of the company and its future prospectus. Since company pays dividends regularly to its investors, th ey do non have any part problem.Clientele Effect There are two types of shareholders in the industry. One group who are accepting regular income as dividends for eg Pensioners. The other group are the ones who are not expecting dividends, because they are interested in the future growth of the company by increasing the capital gain.Arguments against the impactTax effectWhen shareholders cause income from dividends they have to pay tax which will affect their earnings. If the company pay high dividends to the investors, it would affect the earnings of the company. This would also reduce the cash flow of the company if it destinys to make investments.EarningsThe market capitalization of the company depends upon the earning per share of the company and not on the dividend policy of the management. investitureIf the company pays all its earnings to the shareholders as dividend, they would not have sufficient reserves for future projects. Therefore the growth of the company is an imp ortant decision than the decision of the dividend.LiquidityA company would not have any liquid cash left if it pays all earnings and profits to its investors. So liquidity is the main factor in a company as it would affect the business.Arguments for and against, whether a cash dividend is paid or not is irrelevant in the context of shareholder wealth maximizationArguments favoring the impactThe enlighten profit value (NPV) of a company plays a major role when dividends are given to its shareholders. Dividends would not necessarily be paid to its shareholders as destroying shareholders wealth in the real world is replaced with new set of shares.Retained earningsIf the company pays all the income to its shareholders as dividend, then the company would not have sufficient retain earnings to make investment in the profitable projects. If the company needs any funds for the future, it would borrow from sources like equity or debt markets which will increase the cost of the capital becau se the cost of external funds are comparatively higher than the cost of internal funds.Arguments Against the impactInformation content If the company does not pay dividend regularly to its investors, shows a sign of negative signal to the capital market and hence the share price would also decrease in the market and would also affect the growth of the company.One of the major problems is the agency cost between the shareholder and the management. The shareholders generally expect a good growth of the company which would in dig give good dividend to the investors. But, the aim of the management is to grow the company in order to maximize the wealth and the power which may not be of interest to the shareholders.Arguments for and against weather dividend payments should be avoided, as they would lead to a decrease in shareholder wealth.Arguments favoring the impact of shareholders wealthIf the company does not pay dividends to its shareholders, the funds can be utilized for the future growth of the company. There would also be a dual benefit both to the company and the shareholder, where the shareholders may not need to pay an tax on dividend and for the company, they do not need to pay any transaction cost. There is also an air to change the dividend policy from low to high payouts. polity Formulation In a company there is an administrative cost that is involved with the dividend policy which would in turn reduce the earnings of the company.Cost of capital When a dividend payment is reduced, the external financing plays an important role in reducing the cost of capital of the firm. Due to this reduction of cost of capital, the value of the firm has increased because there is an relationship between cost of capital and the value of the firm.Arguments against the impact of shareholders wealthIf a company avoids dividend payment to its investors, shareholders would withdraw their investment that they have invested in the company and thus this would also have an n egative impact on the shareholders wealth.Signalling effect When a dividend payment is avoided there is an signalling effect which effects the growth of the company and will also have an impact on the share price and effect the shareholders wealth.FACTORS alter THE DIVIDEND POLICY OF A COMPANYStability of earnings Companies which have regular income formulate regular dividend policy than those companies having an uneven flow of income. This can be advantageously know by the earnings of the company.Liquidity of Cash The main factor in the dividend decision of a company depends on the cash flow. The higher the funds the company earns is better for the company in order to pay high dividends to the investors. In order to pay dividends the company needs funds and therefore the handiness of cash will be the main factor of the dividend policy.Extent of shareholders A company makes decision against the shareholders for the suspension of the dividend to its investors. On the other hand, a company having carve up of shareholders are distributed forming high and low income group. This would also have difficulties in securing the assets, because of higher dividend.Taxation Policy If a company pays high tax, not the earnings of the company would be affected but also the dividend would be decreased. Tax on dividends is waived by the government only up to a certain limit. This would in turn effect the capital growth of the company. Reduction in tax dividends reduces the value of all the tax payers. The capital gain tax is also likely to be below the shareholders tax rate. Shareholders may also prefer gapital gains to dividends. Directors resolve the conflict between the conflict of interest between the shareholders of a company.Past dividend rates When the company pays dividend to its shareholders, it has to review the rate of dividend paid to the shareholders in the previous years, The dividend rate should be should be equal or more to the past dividend rate.Ability to Borrow however large firms and well established firms can borrow funds from the capital market and other external sources. These companies should have a good payout ratio. And smaller firms who are not well established rely on internal sources, and they would also have to build good reserves by reducing the payout ratio.Legal constraints There were some constraints in the payment of dividends make by the UK government in the year 1960. There was some control in the payment of dividend. As a government measure, to overcome the anti inflation, but later in 1979, they removed these restrictions so the company must know the legal rules and the government policies before forming the dividend policy.Policy of Control This is another main factor for the dividends. The control of the company is determined by the ordinary shares of the company. If the company wants to make investment they need funds. These funds should be obtained from equity capital, If they raise the equity capital, the n ew shareholders will invest in the company so the directors of the company have full control where they would not want to add any new shareholders to the company, and would announce a low dividend rate to its existing shareholders. The directors do not want to add new shareholders because they would not have any control and diversion on the policies of the management.Time for Payment of Dividend Payment of dividends are planned in such a manner that there is no cash flow at the time of issuing dividends, as during the peak time of the company would require funds for urgent finances.Regularity and stability in Dividend Payment Companies maintain dividend equalization fund in order to pay regular dividends to its investors and also have a constant rate of dividends to most of its investors.Investment opportunity While the board of directors make dividend policy decisions, they should consider if there is any profitable project or not. If there is a project in which they have to invest , then they have to announce a lower dividend to its shareholders.Opportunity to collect fundsThe management should think about if there is any source to collect the required funds if needed at a cheaper cost, if not they should not announce more dividends to the shareholders.Growth A growth of a company is one of the major factor and plays an important role when dividends are issued to its shareholders. Growth can be measured in sales, market share and the profit of a company.ConclusionDividend policy is concerned with level of dividends for the shareholders of a company. Thus from the above mentioned two theories, we can conclude the followingAs per the opinion of Director A, dividend should be provided to the shareholders for the following reasonsSignalling effect This conveys a message to its investors showing the current growth of the company and its future prospectus.Clientele Effect If a company pays higher cash dividend to the shareholders, it gives more sign of chances abou t its future to its investors and the increase in dividends may lead directly to an increase in the companys share price in the market.As per the opinion of Director B, Dividend payment is irrelevant to shareholder maximization wealth for the following reasons.If the company pays all the income to its shareholders as dividend, then the company would not have sufficient retain earnings. If the company needs any funds for the future, it would borrow from sources like equity or debt markets which will increase the cost of the capitalAs per the opinion of the Director C, dividend payments should be avoided due to the following reasons.If the company does not pay dividends to its shareholders, the funds can be utilized for the future growth of the company. There would also be a dual benefit both to the company and the shareholder, where the shareholders may not need to pay an tax on dividend and for the company, they do not need to pay any transaction cost.Thus we conclude based on the m anagements views of a company on dividend payments and the effect on firm value. Because the dividend policy is a natural consequence of dividend theory being applied, the conclusions to this are categorised under the dividend policies, such as the managed dividend policy, and also there is a consequence of the relevant dividend theory and the residual dividend policy, a consequence of the irrelevant dividend theory.