The Theory And Arguments Of Dividend Policy Finance Essay

The Theory And Arguments Of Dividend insurance Finance EssayDividend is a cash salary made by a go with to its sh beholders. A companys dividend decision has important implications for both its investing and backing decisions which would what detonating device should be give to the shargonholder and how much money should be kept in the hearty which whitethorn be apply in the later courses.The dividend decision, which consider the amount of funds retained by the company and the amounts to be distributed to the regionholders, is closely linked to both investment and financing decisions. For example the company with few projects should return the unused funds to sh atomic number 18holder by the way of paying more than dividends. A company with almost(prenominal) suitable projects that maintains high dividends will constitute to fund from external sources.In the recent years, the decision what amount to retain and what amount to pay has get going an important corporate de cision. The Management should take into account the expectation of the overlapholders and the outstanding grocery store when fashioning dividend decision.Theory of Dividend PolicyWaston and fountainhead ( 2007) state that in that location are two main theories of dividend insurance which are as followsDividend relevance Theory Lintner (1956) and Gordon (1959) claim that dividend policy affects the value of a wet, because of shareholder pick dividend to crown gain. The logic of their preference regarding dividend is that divided is certain but non capital gain. So, dividend policy affects the value of a company. The assumptions of Gordon findings are investors are run a risk averse and uncertainty augments with regard to whether dividend payments would take place in future.Dividend irrelevance Theory Miller and Modigliani (1961) claim that value of a firm is non influenced by its dividend policy in perfect capital market with or so assumptions. The assumptions which are accepted for the perfect market are as follows on that point is no measure force play on dividend and capital gain in that respect is no transaction costAll the investors are behaving rationally at that place is a perfect marketArguments for and against that a gameyer Cash Dividend Payout Increases the mete out PriceArguments in favor of the statementInformation content Waston and Head (2007) reference that a higher cash dividend payment plays an important exercise to countenance tender information to the investors. high cash dividend indicates that the companys financial designate is strength. tighten passage of arms of Interest Waston and Head ( 2007) states that management tries to ensure their private benefits, whereas owners are concerned most their own interest which cause theatrical problem. higher(prenominal) dividend payment rate decreases conflict of interest, because it indicates that agent (management) is doing all things for the eudaimonia of the shareh olders. jeopardy free Gitman (1997) argues that higher cash dividend reduces the uncertainty of shareholders income, so it leads to gain the share price of a company.Arguments against the statementShortage of Cash High cash dividend payments cause shortage of cash which lead to forgo of making investments in gainful projects and it will act as a force out to reduce the share price earlier than increase.Increase the Cost of big(p) The give company has to manage fund from the external source which is proportional expensive than retained earnings, because of paying higher cash dividend, the capability of the given firm decreases to collect fund from interior source i.e. retained earnings. Therefore, a higher payment of cash dividend increases the cost of capital and decreases the share price. obstruction of Growth A higher payment of cash dividend hinders growth of the firm through squeezing the investment capacity.Arguments for and against that Divided defrayal is Irrelevant to increase the shareholders WealthArgument in favour of the statementHomemade Dividend Dividend is orthogonal to the maximization of shareholders wealth, because of if the company does non pay dividend, shareholders can continue their fixing income through selling some holding shares which is called homemade dividend.Profitability The market price of share depends upon the earnings or profitability of the firm and not the dividend policy of the given firm.Arguments against the statementThe Clientele lay out There are some differences for the different types of investors which invested in the given stock of the firm. Normally, the investors such as Pensioners and Institutional investors expect regular income in order to meet their liabilities. only in case of wealthy investors, 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 Head ( 2007 ) mention that a higher cash dividend payment plays an important role to provide favorable information to the investors . Higher cash dividend indicates that the companys financial condition is strength.Reduce Conflict of Interest Waston and Head ( 2007 ) say that management tries to ensure their personal benefits, whereas owners are concerned about their own interest which cause agency problem. Higher dividend payment rate decreases conflict of interest, because it indicates that agent (management) is doing all things for the wellbeing of the shareholders. chance free Gitman (2009 ) argues that higher cash dividend reduces the uncertainty of shareholders income, so it leads to increase the share price of a company.Argument for and against that Dividend payment should be avoided since it reduces Shareholders WealthArguments in favour of the statementTax effect Shareholders need to pay assess on the dividend received on the shares which decreases their net income as a emergence it will decre ase 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 projects. So, the firm should try to avoid the dividend payment to its shareholders and try to concentrate on its investment opportunities.Argument against the StatementInformation content Waston and Head ( 2007) mention that a higher cash dividend payment plays an important role to provide favorable information to the investors . Higher cash dividend indicates that the companys financial condition is strength.Reduce Conflict of Interest ( 2007) mention that management tries to ensure their personal benefits, whereas owners are concerned about their own interest which cause agency problem. Higher dividend payment rate decreases conflict of interest, because it indicates that agent (management) is doing all things for the wellbeing of the shareholders.Risk free Gitman (2009 ) argues that higher cash dividend reduces the uncertainty of shareholders income, so it leads to increase the share price of a company.Determinants of Dividend PolicySamuels and Brayshaw (1995) and Weston, Beasely and Brigham (1996) mention that the following factors affect the dividend policyConstraints on dividend payments There are some constraints in the dividend payments which includesDebt contract imposes some restrictions because the interest on debt is to be paid before the dividend and it is the obligatory payment.The fount that the dividend payment should not exceed the retaining earning which was mentioned in the balance sheetIt is arena to the availability of the cash , because the dividend is paid only with cash.Investment Opportunities Company which pays more dividends it will postpones the opportunity to invest in the new acceptable projects which dexterity be selected on the basis of Net present value of the project. alternate(a) source of capital When a firm want to raise a capital though either debt or equ ity it have to come some cost which is known 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 debt capital should be referred as external cost and the retained earnings should be mentioned as internal cost. If have retained earning almost, its cost is less when compared to the cost of external cost. If the firms has crocked Retained earning it should not depend upon the profit of firm which is not predictable, and you could not restrict your investment opportunities in new projects.Ownership dilution If the management of the company think that they should not allow any further shares by heave through equity capital or they are reluctant to shorten the ownership it should hold bighearted amount of retaining earning or reserves. If the firm has large number amount of reserves then it need to raise capital for any future projects. Hence, the company which dont like dilution of control should hold fitting amount of reserves or retaining earning and whenever they need they can use for the Business.Effect of dividend policy The effect of dividend policy depend on 4 factors this includes Shareholder desire for on-going future income the perceived riskiness of dividends versus capital gains the tax affect on the capital gain or divided which may depend upon the relevant statues and the information content of dividend.Distributable profits The companies act stipulated that the dividend should be paid out accumulated net realized profit which includes the current profit and the previous accumulated profit. Because there is no concise ex determine of the word accumulated profit in the act the Committee of accountancy Bodies issued guidelines on the determination of the realized and the distributable profits and the mentioned that the profit is as per the business relationship standards and Generally accepted accounting principles i.e., Profit available fo r distribution should be calculated after providing accumulated loosed from the previous year.Liquidity When the firm announces the dividend it should have sufficient cash to pay the dividend otherwise there liquidity position should be strong. Because, the company may generate more profit its does not mean that it should have it have all the profit realised in terms of cash. It may invest some funds in Projects or investment for returns. So the management should consider the liquidity before promulgation of dividend.CONCLUSIONThe dividend policy is the crucial part of the management decision that need to be handled carefully . If they handled properly they need not to worry about the investment decision and financial decision.According to the dividend relevance theory, the dividend policy plays a vital role in hands of the investors because the wrong decision tycoon affect the capital structure of the firm. We got from the theory that dividend give the signal effect to the invest ores and it has a clientele effect so we cant avoid the payment of dividend. On the other hand if we pay dividend regularly year by year it will affect the growth of the company and it will earn liquidity problems. Big company like Mcdonals they avoid the dividend in the intial year and they will create a Brand name across the foundation and later they pay the dividend.