Paying out dividends belongs to the easiest way to communicate financial well-being and shareholder value, since they are sending out a powerful message about future prospects and performances. The willingness, and also the ability of companies to pay out steady dividends and maybe even to increase them, provides the shareholder with valuable information about the company's fundamentals.
Wherever you are looking for information regarding dividends, you will find statements about their affection on stockholders. But where is the point for the companies? What drives companies to pay out dividends, and why do some companies do so and some do not?
There is the opinion of some financial analysts that a dividend policy is irrelevant because investors have the ability to create homemade dividends. That can be done by adjusting the personal portfolio to reflect the investor's own preferences. A second argument suggests that little to no dividend payout is more favorable for investors. This can be led back to the fact that the taxes which have to be paid on dividends are higher than these on capital gains. Furthermore, there is the "advantage" of the reinvestment of the funds in the company. Supporters of this policy argue that companies who save money on dividends will invest this and increase the value of the firm as a whole, which consequently will lift the market value of the stock price. Possibilities for using this money in "a more profitable" way are e.g. the undertaking of more projects, the repurchase of the company's own shares, the acquisition of new companies and profitable assets and the reinvesting in financial assets.
In opposition of these two arguments, there is the idea that a high dividend payout is more important for investors because dividends provide certainty about the company's financial well-being. Actually, there are many examples of how the decrease and increase of a dividend distribution could affect the stock price. Companies that have a long standing history of stable dividend pay-outs would be negatively affected by lowering or omitting dividend distributions; these companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends. Furthermore, companies without a dividend history are generally viewed more favorably when they declare new dividends. Now, should the company decide to follow either the high or low dividend method, it would use one of three main approaches:
Compromise between the two.
Companies using this dividend policy decide to especially rely on internally generated equity in order to finance new projects. As a result, the dividend payments can only be financed with the leftover equity after all project capital requirements are met. That leads to the fact that these companies usually try to maintain a certain balance in their debt/equity ratio and that they decide to distribute dividends only after having carefully examined how much money is left over after all operating and expansion expenses have been met.
The fluctuation of dividends created by the residual policy significantly contrasts the certainty of the dividend stability policy. With the stability policy, companies may choose a cyclical policy that sets dividends at a fixed fraction of quarterly earnings, or they may choose a stable policy whereby quarterly dividends are set at a fraction of yearly earnings. In either case, the aim of the dividend stability policy is to reduce uncertainty for investors and to provide them with income.
The final approach is a combination of the residual and the stable dividend policy. While using this method, the companies tend to view the debt/equity ratio as a long-term rather than a short-term goal. Nowadays, this method is commonly used by companies that pay dividends. As these companies will generally experience business cycle...
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