Dividend Policy: A Review of Theories and Empirical Evidence Husam-Aldin Nizar Al-Malkawi Corresponding Author, Faculty of Business, ALHOSN University P.O. Box 38772 - Abu Dhabi, UAE E-mail: firstname.lastname@example.org Michael Rafferty Senior Research Analyst, WRC, University of Sydney, Australia E-mail: email@example.com Rekha Pillai Faculty of Business, ALHOSN University, Abu Dhabi, UAE E-mail: firstname.lastname@example.org Abstract The literature on dividend policy has produced a large body of theoretical and empirical research, especially following the publication of the dividend irrelevance hypothesis of Miller and Modigliani (1961). No general consensus has yet emerged after several decades of investigation, and scholars can often disagree even about the same empirical evidence. This paper aims at providing the reader with a comprehensive understanding of dividends and dividend policy by reviewing the main theories and explanations of dividend policy including dividend irrelevance hypothesis of Miller and Modigliani, bird-in-the-hand, tax-preference, clientele effects, signalling, and agency costs hypotheses. The paper also attempts to present the main empirical studies on corporate dividend policy. However, due to the enduring nature and extensive range of the debate about dividend policy which has spawned a vast amount of literature that grows by the day, a full review of all debates is not feasible. The paper reaches at a conclusion that the famous statement of Fisher Black about dividend policy "the harder we look at the dividends picture, the more it seems like a puzzle, with pieces that just do not fit together" (Black, 1976, p. 5) is still valid.
Keywords: Dividends, Dividend Policy, Dividend Policy Theories JEL Classification Codes: G30, G32
In corporate finance, the finance manager is generally thought to face two operational decisions: the investment (or capital budgeting) and the financing decisions. The capital budgeting decision is concerned with what real assets the firm should acquire while the financing decision is concerned with how these assets should be financed. A third decision may arise, however, when the firm begins to generate profits. Should the firm distribute all or proportion of earned profits in the form of dividends to the shareholders, or should it be ploughed back into the business? Presumably, in taking any course of action, managers should concentrate on how to maximise the wealth of shareholders for whom the 171
firm is being managed. Managers must not only consider the question of how much of the company’s earnings are needed for investment, but also take into consideration the possible effect of their decisions on share prices (Bishop et al., 2000). The term ‘dividend policy’ refers to “the practice that management follows in making dividend payout decisions or, in other words, the size and pattern of cash distributions over time to shareholders” (Lease et al., 2000, p.29). This issue of dividend policy is one that has engaged managers since the birth of the modern commercial corporation. Surprisingly then dividend policy remains one of the most contested issues in finance. The study of dividend policy has captured the attention of finance scholars since the middle of the last century. They have attempted to solve several issues pertaining to dividends and formulate theories and models to explain corporate dividend behaviour. The dividend enigma has not only been an enduring issue in finance, it also remains unresolved. Almost three decades ago Black (1976) described it as a “puzzle”, and since then an enormous amount of research has occurred trying to solve the dividend puzzle. Allen, Bernardo and Welch (2000, p.2499) summarised the current consensus view when they concluded “Although a number of theories have been put...