Dividend Decisions

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UNIT-V

• Dividend Decisions Dividend decisions meaning,
  factors influencing dividend, forms of dividends,
  Dividend theories Relevance Theory Walters
  model, Gordon's model, Irrelevance theory MM
  Hypothesis

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• A dividend is the distribution of a company's
  earnings to its shareholders and is determined by
  the company's board of directors.
• Dividend policy outlines how a company will
  distribute its dividends to its shareholders.
  These structures detail specifics about payouts,
  including how often, when, and how much is
  distributed.

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Objectives of dividend decision

• Wealth Maximization
• Future Prospects
• Stable rate of dividend
• Degree of control

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Determinants of Dividend Policy

• Companys earning capacity
• Financing policy of the company
• Liquidity of funds (Availability of cash flow)
• Dividend policy of competitors
• Past dividend rates
• Debt obligations
• Ability to borrow
• Growth needs of the company
• Desire and type of shareholders.

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• Types of dividend Policy
• Regular dividend policy
• Irregular dividend policy
• Stable dividend policy
• No dividend policy

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• Forms of Dividend
• Cash dividend
• Stock dividend
• Bond dividend /Scrip dividends
• Property Dividend
• Equity dividend
• Preference dividend
• Interim dividend
• Regular dividend

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Dividend Theory 

• Walter Model
• His approach explains that dividend decisions
  are relevant and affect the value of the firm.
• The relationship between rate of return (r)
  earned by the company and its cost of capital
  (Ke) is very significant in determining the
  dividend policy.

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• Assumptions of Walters model
• Life of the company is infinite
• Constant dividend and earnings per share
• Total payout or retention
• Financing from retained earnings
• Rate of return (r) and Cost of Capital (Ke) are
  remains constant.
• Walters model -Types of firms
• Growth firms (r gt K), Payout is not required
• Normal Firms(r K), Payout is not required
• Declining Firms (rltK) Entire earnings should be
  distributed as earnings.

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Gordons Model

• The firm is an all equity firm.
• No external financing is used and investment
  programmes are financed exclusively by retained
  earnings.
• r and ke are constant.
• The firm has a perpetual life
• The retention ratio, once decided is constant.
• Thus, the growth rate, ( g br) is also
  constant.
• Ke gt br

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• According To Gordon
• When RgtK the price per share increases as the
  dividend payout ratio decreases.
• When RltK the price per share increases as the
  dividend payout ratio increases.
• When R K the price per share remains same
  unchanged in response to change in the payout
  ratio.

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Miller and Modigliani Model (MM Theory)

• The dividend irrelevance theory states that a
  company's dividend policy does not impact its
  overall value or stock price, assuming
  perfect market conditions.
• Assumptions
• Capital markets are perfect.
• Investors behave rationally. Information is
  freely available to them and there are
  no floatation and transaction costs.
• There are no taxes and no differences in the tax
  rates applicable to capital gains and dividends.
• The firm has a fixed investment policy.
• Risk or uncertainty does not exist. Investors can
  forecast future prices and dividends with
  certainty. One discount rate can be used for all
  securities at all times.

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• Summary Dividend Theories
• Both types of dividend theories rely upon several
  assumptions to suggest whether the dividend
  policy affects the value of a company or not.
  However, many of these assumptions do not stand
  in the real world. They have been used only to
  simplify the situation and the theory.
• For example, suppose the management of a
  particular company decides to cut down on the
  dividend payout and retain more of its earnings.
  According to the Walter model, this happens when
  the internal ROI is greater than the cost of
  capital of the company. However, in reality, this
  may not mean that it has better use of the funds
  in hand and can provide a higher ROI than its
  cost of capital. The company may be going through
  a tough phase and needs more finance. Moreover,
  many assumptions in the above models, such as
  that of constant ROI, cost of capital and absence
  of taxes, transaction costs, and floatation
  costs, do not hold ground in the real world. A
  perfect capital market rarely exists, and
  investment opportunities, as well as future
  profits, can never be certain. Thus, we should
  use these theories cautiously. We should use our
  judgment and not rely upon them completely to
  arrive at the value of the company and make
  investment decisions. All these should remain
  only reference points and not conclusive points.