Dividends are considered a credible signaling device because of the dissipative costs involved. Dividend Theories In this section we describe some prevailing dividend theories and hypotheses. The ideals of this school of thought were solidified mainly by Gordon 1963 , Lintner 1962 and Walter 1963. The capital needs of these units for trading with overseas nations then increased greatly and gradually evolved into joint stock companies Kindleberger, 1984. This proposition has since become known as the 'information content of dividends' or signaling hypothesis. These types of dividend are issued when a company does not have enough liquidity and require some time to convert its current assets into cash. The value of shares is represented by their market price which is a reflection of the firm's financial decisions that include investment or long-term asset-mix decision, financing or capital-mix decision and dividend or profit allocation decision.
Furthermore, the study pinpoints how these negative impression management behaviours thwart the developmental processes in Nigeria and outlines some suggestions to prevent negative impression management behaviours by individuals and organizations in order to move the country forward. This informational gap between insiders and outsiders may cause the true intrinsic value of the firm to be unavailable to the market. Article shared by : After reading this article you will learn about the Meaning and Types of Dividend Policy. The benefits of stable dividend policy are 1 it helps in raising long-term finance. Similarly, dividend cuts may be considered as a signal that the firm has poor future prospects bad news , and the share price may then react unfavorably.
Dividends may feature in a range of other portfolio strategies, as well, such as. Consequently, a firm can pay dividends and raise funds to undertake the optimum investment policy. Critique The validity of the Modigliani and Miller theory is highly dependent on two critical assumptions, which unfortunately are not tenable in the real world. First, because it satisfies one's desire to better understand the dividend puzzle. The high dividend payout share today reduces the cost of the capital, thereby reducing the uncertainty about the future and thus increases the value of the share.
There are other subsidiary hypotheses which support the notion of dividend relevance. The firm's life runs to perpetuity. Assumptions of the Bird-in-the-Hand theory This theory is based on a number of assumptions, as enumerated below: 1. This approach is volatile, but it makes the most sense in terms of business operations. These include the tax preference theory, the Agency theory, the Signaling Hypothesis, and The Clientele Effect Hypothesis, Dividend Irrelevance Theories: 1.
As hypothesised by M — M, r should be equal for all shares. For example, a current income strategy seeks to identify investments that pay above average distributions i. Dividend policy refers to the policy chalked out by companies regarding the amount it would pay to their shareholders as dividend. Growth, Beta and Agency Costs as Determinants of Dividend payout Ratios, The Journal of Financial Research 5, 249-259. Accordingly, it would not be surprising to find that managers are reluctant to announce a reduction in dividends. This means that which do not pay dividends might actually end up paying nothing to their shareholders.
The subsidiary theories supporting the dividend relevance hypothesis are all based on observed phenomena across different domains. The implausible set of assumptions upon which this theory is based are that financial markets are perfect and shareholders can construct their own dividend policy simply by buying or selling shares in the market as they desire. Capital gains occur in distant future, and therefore, are considered uncertain. An examination of over 8,500 dividend changes shows that price reactions to dividend increases are significantly more positive and to dividend decreases significantly more negative for high-yield stocks. Company leaders are often the largest shareholders and have the most to gain from a generous dividend policy. This reflects the assumption that the most profitable investments are made first and then the poorer investments are made.
In the end, the impact will be the same. The policy of constant pay-out is preferred by the firms because it is related to their ability to pay dividends. As a result of the floatation cost, the external financing becomes costlier than internal financing. In particular, this theory holds that investors are not indifferent between dividends today and an equivalent amount of capital gains in the future. Most companies view a dividend policy as an integral part of the corporate strategy. Thus, the dividend is split in to two parts.
The firm has a very long or infinite life. Illustration: Qmega Company has a cost of equity capital of 10%, the current market value of the firm V is Rs 20,00,000 Rs. In this paper, we explore various theories which have been postulated to explain dividend payment behavior of firms. Walterargues that the choice of dividend policies almost always affects the value of the enterprise. Only when the earnings of the company have permanently increased, the extra dividend should be merged with regular normal dividend and thus rate of normal dividend should be raised. Therefore, if floatation costs are considered external and internal financing, i. So which dividend theory is correct? These might be bird-in-the-hand-type investors.