Dividend Decision
Financial Management
Unit 15
Unit 15
Structure 15.1 Introduction 15.2 Traditional Approach 15.3 Dividend Relevance Model 15.3.1 15.3.2 Walter Model Gordon’s Dividend Capitalization Model
Dividend Decision
15.4 Dividend Irrelevance Theory: Miller and Modigliani Model 15.5 Stability of Dividends 15.6 Forms of Dividends 15.7 Stock Split 15.8 Summary Terminal Questions Answers to SAQs and TQs 15.1 Introduction Dividends are that portion of a firm’s net earnings paid to the shareholders. Preference shareholders are entitled to a fixed rate of dividend irrespective of the firm’s earnings. Equity holders’ dividends fluctuate year after year. It depends on what portion of earnings is to be retained by the firm and what portion is to be paid off. As dividends are distributed out of net profits, the firm’s decisions on retained earnings have a bearing on the amount to be distributed. Retained earnings constitute an important source of financing investment requirements of a firm. However, such opportunities should have enough growth potential and sufficient profitability. There is an inverse relationship between these two – larger retentions, lesser dividends and vice versa. Thus two constituents of net profits are always competitive and conflicting. Dividend policy has a direct influence on the two components of shareholders’ return – dividends and capital gains. A low payout and high retention may have the effect of accelerating earnings growth. Investors of growth companies realize their money in the form of capital gains. Dividend yield will be low for such companies. The influence of dividend policy on future capital gains is to happen in
Sikkim Manipal University
231
Financial Management
Unit 15
distant future and therefore by all means uncertain. Share prices are a reflection of many factors including dividends. Some investors
Unit 15
Unit 15
Structure 15.1 Introduction 15.2 Traditional Approach 15.3 Dividend Relevance Model 15.3.1 15.3.2 Walter Model Gordon’s Dividend Capitalization Model
Dividend Decision
15.4 Dividend Irrelevance Theory: Miller and Modigliani Model 15.5 Stability of Dividends 15.6 Forms of Dividends 15.7 Stock Split 15.8 Summary Terminal Questions Answers to SAQs and TQs 15.1 Introduction Dividends are that portion of a firm’s net earnings paid to the shareholders. Preference shareholders are entitled to a fixed rate of dividend irrespective of the firm’s earnings. Equity holders’ dividends fluctuate year after year. It depends on what portion of earnings is to be retained by the firm and what portion is to be paid off. As dividends are distributed out of net profits, the firm’s decisions on retained earnings have a bearing on the amount to be distributed. Retained earnings constitute an important source of financing investment requirements of a firm. However, such opportunities should have enough growth potential and sufficient profitability. There is an inverse relationship between these two – larger retentions, lesser dividends and vice versa. Thus two constituents of net profits are always competitive and conflicting. Dividend policy has a direct influence on the two components of shareholders’ return – dividends and capital gains. A low payout and high retention may have the effect of accelerating earnings growth. Investors of growth companies realize their money in the form of capital gains. Dividend yield will be low for such companies. The influence of dividend policy on future capital gains is to happen in
Sikkim Manipal University
231
Financial Management
Unit 15
distant future and therefore by all means uncertain. Share prices are a reflection of many factors including dividends. Some investors