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Pay Out Decision

This document discusses dividend decision and policy. It outlines the objectives of dividend policy which include balancing shareholder needs for income and firm needs for reinvestment. It also discusses the relevance vs irrelevance of dividends according to different models like Gordon's model and Miller and Modigliani's hypothesis. Key factors that influence dividend policy decisions are also summarized like taxes, signaling effects, and strategic considerations around liquidity, investment opportunities, and access to finance. Survey responses from US and India on important considerations in dividend decisions are also presented.

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216 views

Pay Out Decision

This document discusses dividend decision and policy. It outlines the objectives of dividend policy which include balancing shareholder needs for income and firm needs for reinvestment. It also discusses the relevance vs irrelevance of dividends according to different models like Gordon's model and Miller and Modigliani's hypothesis. Key factors that influence dividend policy decisions are also summarized like taxes, signaling effects, and strategic considerations around liquidity, investment opportunities, and access to finance. Survey responses from US and India on important considerations in dividend decisions are also presented.

Uploaded by

dawncpain
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Dividend Decision

OBJECTIVES OF DIVIDEND POLICY


Firms Need Funds
Shareholders Need Income
Dividend policy involves the balancing of
the shareholders desire for current
dividends and the firms needs for funds
for growth.
Objective Maximize Shareholders Return.

** Dividends can be paid out of free


reserves (past profit) only not from capital.

Relevance Vs.
Irrelevance
Walter's Model
Gordon's Model
The Bird in the Hand Argument
Residual theory of Dividend
Modigliani and Miller Hypothesis

Gordon Model
Market value of a share is equal to
the present value of an infinite
stream of dividends to be received
by shareholders.

The basic assumptions of


GORDONS model
The firm has perpetual life span
The only source of financing
available to the firm is retained
earnings
The return on investment and cost of
capital are constant throughout the
life of the firm.
The cost of equity is greater than its
growth rate.

Interpretation
The market value of the share Po
increases with the retention ratio b,
for the firms with growth opportunity
i.e. r > k.
The market value of the share Po
increases with the payout ratio, (1
b) for declining firms with r < k.
The market value of the share is not
affected by dividend policy when r =
k.

DIVIDEND AND UNCERTAINTY:


THE BIRD-IN-THE-HAND ARGUMENT

Investors are risk averse.


They consider distant dividends as
less certain than near dividends.
The Rate at which an investor
discounts his dividend stream from a
given firm increases with the futurity
of dividend stream and hence
lowering share prices.

DIVIDEND IRRELEVANCE: THE


MILLERMODIGLIANI (MM)
HYPOTHESIS

According to M-M, under a perfect


market situation, the dividend policy of a
firm is irrelevant as it does not affect the
value of the firm.
They argue that the value of the firm
depends on firm earnings which results
from its investment policy. Thus, when
investment decision of the firm is given,
dividend decision is of no significance.

Taxes on Dividend & Capital Gains (U.S)


Year

Capital
Gains

Dividends

1971 - 78

35%

70%

1979 81

28%

70%

1982 86

20%

50%

1987 88

28%

39%

1988 90

28%

28%

1991 92

28%

31%

1993 96

28%

40%

1997
2000

20%

40%

2001
2002

20%

39%

2003 - 2008

15%

15%

Practical Aspect
Constants payment of dividend gives
a strong downward support to the
stock price.

Forms of Dividend
Cash Dividends
Bonus Shares (Stock Dividend)

Bonus Issue
Capitalization of Reserves
When share holders receives bonus
shares they receive Nothing of Value
immediately (as the share price fall
exactly the same proportion).

Signaling from Bonus


Shares
Indication of higher future profits
Future dividends may increase
Conservation of cash
Psychological value

Stock Split
A share split is a method to increase
the number of outstanding shares
through a proportional reduction in
the par value of the share.
A share split affects only the par
value and the number of outstanding
shares; the shareholders total funds
remain unaltered.

Bonus Share vs. Share


Split
The bonus issue and the share split are similar
except for the difference in their accounting
treatment.
In the case of bonus shares, the balance of the
reserves and surpluses account decreases due
to a transfer to the paid-up capital and the
share premium accounts. The par value per
share remains unaffected.
With a share split, the balance of the reserve
and surplus accounts does not change, but the
par value per share changes.

Strategic Determinants of Dividend Policy


Liquidity: Profitable firm may not be cash rich. For a cash
poor firm it is difficult to pay dividend as it will further
increase the cash outflow.
Investment opportunity: Pay low dividend if future
investment opportunity exists. Also pay out depends on the
life cycle of the business.
Access to finance: How quickly firm able to get money from
the finance market. (the condition of the capital market).
Corporate control: To finance new investment if firm needs
to issue equity it will decrease the proportion of holding of
the existing share holders and dilute their proportional
stake.
Investors preference: What they prefer pay out or retention.
It also depends on the size of the firm.
Dividend stability: Consistent payment of dividend.
Taxes: Dividend income is not taxable in the hands of the
investors but capital gain tax might be.

Survey response on Dividend decision in USA


Policy Statement

% who
strongl
y
agrees

We try to avoid reducing dividend per share

93.8%

We try to maintain a small dividend from year to year

89.6%

We consider the level of dividend per share that we


have paid in recent quarters

88.2%

We are reluctant to make dividend change that might


have to be reversed in future

77.9%

We consider the change or growth in dividend per


share

66.7%

We consider the cost of raising external capital to be


smaller than the cost of cutting dividend

42.8%

We pay dividend to attract investors

41.7%

Survey response on Dividend decision in India


Policy Statement

% who
strongl
y
agrees

Dividend change follows shift in long term earnings

85.2%

Has long term target dividend pay-out ratio

81.5%

Focus more on absolute level of dividend than


dividend change

67.9%

Dividend payout ratio affects the market value of the


firm

71.6%

Dividend provides signaling mechanism of future


prospect of the firm.

71.6%

Willing to rescind/withdraw dividend increase in the


event of growth opportunity

56.8%

Cash dividend as residual after financing desired


investment from earnings

46.9

Survey response on Dividend decision in USA


Policy Statement

% who
thinks
it is
very
importa
nt

Maintaining consistency with our historic dividend


policy

84.1%

Stability in future dividend

71.9%

A sustainable change in earnings

67.1%

Attracting individual investors to purchase our stock

52.5%

Availability of good investment opportunity for our


firm to pursue

47.6%

Attracting retail investors to purchase our stock

44.5%

Personal taxes our shareholders pay when receiving


dividends

21.1%

Flotation costs to issue new equity

9.3%

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