Topics: Dividend, Finance, Stock market Pages: 7 (2052 words) Published: March 29, 2014
Dividend policy is concerned with financial policies regarding paying cash dividend in the present or paying an increased dividend at a later stage. Whether to issue dividends, and what amount, is determined mainly on the basis of the company's unappropriated profit (excess cash) and influenced by the company's long-term earning power. When cash surplus exists and is not needed by the firm, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program. If there are no NPV positive opportunities, i.e. projects where returns exceed the hurdle rate, and excess cash surplus is not needed, then – finance theory suggests – management should return some or all of the excess cash to shareholders as dividends. This is the general case, however there are exceptions. For example, shareholders of a "growth stock", expect that the company will, almost by definition, retain most of the excess earnings so as to fund future growth internally. By withholding current dividend payments to shareholders, managers of growth companies are hoping that dividend payments will be increased proportionality higher in the future, to offset the retainment of current earnings and the internal financing of present investment projects. Management must also choose the form of the dividend distribution, generally as cash dividends or via a share buyback. Various factors may be taken into consideration: where shareholders must pay tax on dividends, firms may elect to retain earnings or to perform a stock buyback, in both cases increasing the value of shares outstanding. Alternatively, some companies will pay "dividends" from stock rather than in cash; see Corporate action. Financial theory suggests that the dividend policy should be set based upon the type of company and what management determines is the best use of those dividend resources for the firm to its shareholders. As a general rule, shareholders of growth companies would prefer managers to have a share buyback program, whereas shareholders of value or secondary stocks would prefer the management of these companies to payout surplus earnings in the form of cash dividends. Contents

1 Concept
2 Relevance of dividend policy
2.1 Walter's model
2.1.1 Assumptions of the Walter model
2.1.2 Model description
2.1.3 Mathematical representation
2.1.4 Criticism
2.2 Gordon's Model
2.2.1 The Assumptions of the Gordon model
2.2.2 Model description
2.2.3 Mathematical representation
2.2.4 Conclusions on the Walter and Gordon Model
2.3 Capital structure substitution theory & dividends
2.3.1 Mathematical representation
2.3.2 Conclusion
3 Irrelevance of dividend policy
3.1 Residuals theory of dividends
3.1.1 Extension of the theory
3.1.2 Conclusion
3.2 Modigliani-Miller theorem
3.2.1 Assumptions of the MM theorem
3.2.2 Model description
4 See also
5 External links
6 References
Coming up with a dividend policy is challenging for the directors and financial manager a company, because different investors have different views on present cash dividends and future capital gains. Another confusion that pops up is regarding the extent of effect of dividends on the share price. Due to this controversial nature of a dividend policy it is often called the dividend puzzle. Various models have been developed to help firms analyse and evaluate the perfect dividend policy. There is no agreement between these schools of thought over the relationship between dividends and the value of the share or the wealth of the shareholders in other words. One school consists of people like James E. Walter and Myron J. Gordon (see Gordon model), who believe that current cash dividends are less risky than future capital gains. Thus, they say that investors prefer those firms which pay regular dividends and such dividends affect the market price of the share. Another school linked to Modigliani and...
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