Effect of Dividend Policies

Topics: Dividend, Stock, Dividend yield Pages: 6 (1970 words) Published: January 11, 2013
The optimal dividend policy of a firm depends on investor’s desire for capital gains as opposed to income, their willingness to forgo dividend now for future returns, and their perception of the risk associated with postponement of returns. However any normative approach to dividend policy intended to be operative under real world conditions should consider the firms investment opportunities, any preferences that investors have for dividends as opposed to capital gains and vice versa, and difference in “cost” between retained earnings and new equity issues.

Various firms adopt dividend policies depending on the company’s articles of association and the prevailing economic situation. Some make high pay out, while others make low pay out and yet others pay stock dividends (bonus issue) in lieu of or in addition to cash dividend while others pay cash only. All in a bid to maximize shareholders wealth which, in this case, is the market value of the firm’s common stock. Modigliani and Miller (1961) demonstrated the irrelevance of dividend policy under a set of assumption, that is, dividend policy has no effect on stock prices. But when these assumptions are relaxed, the theory begins to collapse. This raises the question does dividend policy have any effect on the value of firms in Nigeria? If yes, to what extent? 2

Objective of Study
The objective of this study is to critically examine the possible effects that a firm’s dividend policy might have on the market price of its common stock and also, those factors that influence firm’s dividend policy in general.

It further attempts at identifying other factors that influence share price behaviour of quoted companies in Nigeria, and finally identifies the most commonly practiced dividend policy in Nigeria.

Theoretical Framework
Pandy (1979) defines dividend as that portion of a company’s net earnings which the directors recommend to be distributed to shareholders in proportion to their share holdings in the company. It is usually expressed as a percentage of nominal value of the company’s ordinary share capital or as a fixed amount per share.

Dividends are usually paid out of the current year’s profit and sometimes out of general reserves. They are normally paid in cash, and this form of dividend payment is known as cash dividend. Another option available to a company for the distribution of earnings is by stock dividend (bonus issue) which is supplementary to cash dividend. When cash dividend is paid to shareholders, it has an adverse effect on the liquidity position and the reserves of the firm as it tends to reduce both of them (cash and reserves). Unlike cash lend, stock dividend does not affect the total net work of the firm, as it is a capitalization of owners’ equity portion.

Furthermore, according to section 370 sub-section (1) of CAMA, a company may in the annual general meeting, declare dividend only on the recommendation of the Directors. The Company may from time to time pay to the members such interim dividends as appear to the directors to be justified by the profits of the company. According to sub-section (3), the general meetings shall have power to decrease the amount of dividend recommended by the directors, but shall have no power to increase the amount recommended. While sub-section (5) stated that, subject to the provisions of these act, dividend shall be payable only out of the distributable profit of the company.

Furthermore, section 381 of CAMA states that a company shall not declare or pay dividends if there are reasonable grounds for believing the company is or would be, after the payment, unable to meet up with or pay its liabilities as they become due. According to Van Home (1971) dividend policy entails the division of earnings between shareholders and reinvestment in the firm. Retained earnings are a significant source of funds for financing corporate growth, but dividend constitutes the cash flows that accrue to shareholders....
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