Effect of Dividend Policies Sample Essay

The optimum dividend policy of a steadfast depends on investor’s desire for capital additions as opposed to income. their willingness to waive dividend now for future returns. and their perceptual experience of the hazard associated with delay of returns. However any normative attack to dividend policy intended to be operative under existent universe conditions should see the houses investing chances. any penchants that investors have for dividends as opposed to capital additions and frailty versa. and difference in “cost” between retained net incomes and new equity issues.

Assorted houses adopt dividend policies depending on the company’s articles of association and the prevalent economic state of affairs. Some make high wage out. while others make low wage out and yet others pay stock dividends ( bonus issue ) in stead of or in add-on to hard currency dividend while others pay hard currency merely. All in a command to maximise stockholders wealth which. in this instance. is the market value of the firm’s common stock. Modigliani and Miller ( 1961 ) demonstrated the irrelevancy of dividend policy under a set of premise. that is. dividend policy has no consequence on stock monetary values. But when these premises are relaxed. the theory begins to fall in. This raises the inquiry does dividend policy have any consequence on the value of houses in Nigeria? If yes. to what extent? 2

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Aim of Study
The aim of this survey is to critically analyze the possible effects that a firm’s dividend policy might hold on the market monetary value of its common stock and besides. those factors that influence firm’s dividend policy in general.

It farther attempts at placing other factors that influence portion monetary value behavior of quoted companies in Nigeria. and eventually identifies the most normally adept dividend policy in Nigeria.

Theoretical Model
Pandy ( 1979 ) defines dividend as that part of a company’s net net incomes which the managers recommend to be distributed to stockholders in proportion to their portion retentions in the company. It is normally expressed as a per centum of nominal value of the company’s ordinary portion capital or as a fixed sum per portion.

Dividends are normally paid out of the current year’s net income and sometimes out of general militias. They are usually paid in hard currency. and this signifier of dividend payment is known as hard currency dividend. Another option available to a company for the distribution of net incomes is by stock dividend ( bonus issue ) which is auxiliary to hard currency dividend. When hard currency dividend is paid to stockholders. it has an inauspicious consequence on the liquidness place and the militias of the house as it tends to cut down both of them ( hard currency and militias ) . Unlike hard currency lend. stock dividend does non impact the entire net work of the house. as it is a capitalisation of owners’ equity part.

Furthermore. harmonizing to subdivision 370 sub-section ( 1 ) of CAMA. a company may in the one-year general meeting. declare dividend merely on the recommendation of the Directors. The Company may from clip to clip wage to the members such interim dividends as appear to the managers to be justified by the net incomes of the company. Harmonizing to sub-section ( 3 ) . the general meetings shall hold power to diminish the sum of dividend recommended by the managers. but shall hold no power to increase the sum recommended. While sub-section ( 5 ) stated that. topic to the commissariats of these act. dividend shall be collectible merely out of the distributable net income of the company.

Furthermore. subdivision 381 of CAMA provinces that a company shall non declare or pay dividends if there are sensible evidences for believing the company is or would be. after the payment. unable to run into up with or pay its liabilities as they become due. Harmonizing to Van Home ( 1971 ) dividend policy entails the division of net incomes between stockholders and reinvestment in the house. Retained net incomes are a important beginning of financess for financing corporate growing. but dividend constitutes the hard currency flows that accrue to stockholders. There exist two divergent schools of idea with respects to these. the dividend policy and the maintained earning policy.

Dividend policy suggests a positive attitude for. it is a deliberate policy to keep or increase dividend at a certain degree with the ultimate purpose of prolonging the monetary value of the ordinary portions on the stock exchange. This is because capital markets are non perfect. although stockholders are apathetic between dividend and maintained net incomes due to market imperfectnesss and uncertainness. but they give a higher value to the current twelvemonth dividend than the future dividend and capital additions. Therefore the payment of dividend has a strong influence on the market monetary value of the portions. Management might keep a dividend degree even at the disbursal of liquidness or forced into borrowing to make so. With this attack it holds that dividends. on the other manus. are desirable from the stockholders point of position. as increasing their current wealth and accordingly dividend degree determines portion monetary value every bit good as indicates the chance of profitableness of the house.

On the other manus. net income keeping policy tends to propose a more inactive residuary attitude towards dividend. that is. a inactive attitude towards keeping. Dividend wage out reduces the sum of net incomes to be retained in the house and impact the entire sum of internal funding. When dividends are treated as a funding determination. the net earning of the house may be viewed as a important beginning of financing the growing of the house. Dividends paid to stockholders represent a distribution of net incomes that can non be productively reinvested by the house. The attack to dividend is viewed simply as a residuary determination. This theory is known as the residuary theory of dividend and was foremost proposed by Miller and Modiliani in 1961. Investor prefer to hold the house retain and reinvest net incomes instead than pay them out in dividend if the return on the investing net incomes exceeds the rate of return the investors could themselves obtain on other comparative investing. Otherwise. the investors prefer dividend. Relevance of Dividend

Another school of idea holds that without Modigiani and Miller’s restrictive premises. their statement prostrations. They asserted that since. in world investors operate in a universe of securities firm fees. revenue enhancements. and uncertainness. it is better to see the house in the visible radiation of these factors.
The taking advocate of the relevancy of dividend theory. Gordon ( 1962 ) suggests that stockholders do hold a penchant for current dividends. that. in fact subject is direct relationship between the dividend policy of a house and its market value. Gordon argues that investors are by and large risk-averters and attach less hazard to current as opposed to future dividends or capital additions. This ‘birds r’ hand” statement suggest that a firm’ dividend policy is relevant since investors prefer some dividend now in order to cut down their uncertainness. When investors are unsure about their returns they discount the firm’s future net incomes at a lower rate therefore puting a higher value on the house.

Another author. Walter ( 1963 ) was of the sentiment that dividend policies in most instances do impact the value of the house. The consequence of the optimal dividend policy on the relationship between the firm’s internal rate of return ( R ) and its cost of capital ( K ) harmonizing to him. is a growing map of the house where R & gt ; k. all net incomes can be reinvested. hence. the house is assumed to hold sample profitable chances so as to maximise the value per portion over and above the rate expected by stockholders. In a normal house where r=k. dividend policy have no consequence on the market value per hare since the rate of return is equal to the cost of capital. In a worsening house where the optimal payout ratio should be 100 % to enable addition in the market value per portion. Walter expressed this as therefore: k-dr

Where P Market value of the portion
E = Earnings per portion
K = Cost of capital
R = Internal rate of return
vitamin D = Current dividend
This Walter theory has been criticized because R and K are non changeless in existent life state of affairs. Furthermore. the non-existence of external funding makes it weak. The firm’s R decreases as more investing occurs and K alterations straight with the firm’s hazard. It should be understood here that Walter’s model though weak. recognizes the fact that dividend policy is relevant. harmonizing to Samuels and Wilkes ( 1975 ) .

The proprietors of a company portion are entitled to a gross watercourse of dividends. The value of the portion corresponds to the present value of this steam of dividends payments. Obviously. there is considerable uncertainness environing the size of the future dividends. so it is as a consequence of alteration outlooks about future dividends that portion monetary values fluctuate. The proprietor considers his returns as accruing non merely from dividend payments but from the extra additions ensuing from any capital grasp on the portion. Normally he does non mean to keep the portion in sempiternity. he wishes to sell the portion and obtain capital additions. but when he sells the portion. the purchaser is besides merely buying a watercourse of future dividend outlooks. The ground the capital addition outlook arises is because of outlook about future dividend watercourse rise between the clip when the investor purchases the portions and when he sells them.

This theory can be demonstrated. Suppose an investor buys a portion anticipating to keep it for two old ages: The value of the portion to him is the present value of the two old ages dividend payment. plus the discounted value of the monetary value he anticipate to have on selling the portion. If P0 = Price of portion today

P2 = Price of portion at the terminal of the 2nd twelvemonth
D1 = Dividend per portion to be received at the terminal of 1st twelvemonth 1 = Discount rate. and
D2 = Dividend at the terminal of the 2nd twelvemonth. so
Po = D1 + D2 + P2
( 1+i ) ( 1+i ) 2 ( 1+i ) 2
The investor who buys the portion at the terminal of the 2nd twelvemonth wages P2 for it and expects to keep it for two farther old ages. so. looked at from clip 0 will give
P2 D3 D4 P4
( 1+i ) 2 ( 1+i ) 3 ( 1+i ) 4 ( 1+i ) 4
Rewritten as
P0 = ? Dt / ( 1 +i ) T
The theory demonstrated supra is in line with Graham. Dodd and Cottle’s statement that “the prevailing rate dividend has found full contemplation is a by and large accepted theory of investing value which states that a common stock is worth the amount of the full dividend to be paid on it in the hereafter. each discounted to its present worth” . Methodology

This survey basically falls under the ex station factor design type because there is no experiment involved. but instead is designed to prove an event that has already taken topographic point. Therefore it deals with historical facts about dividend policy and its effects on the value of Nigerian houses.

The primary informations were collected through personal interviews with a stockbroker. bankers and the members of staff of the Nigerian stock exchange. Kaduna subdivision. This was to enable a thorough complementary presentation with the secondary informations since ; the informations used in this survey is chiefly secondary informations being document analysis and revaluation. The informations machinery adopted for this survey is the published histories of selected house for the relevant old ages sampled for analysis. This enabled the aggregation of the common stock monetary value list of the selected houses. obtained from the Nigerian stock exchange Kaduna subdivision. Samples of 15 quoted companies were selected. The footing of choosing these companies was to guarantee that all industries are covered but as the survey progressed. it became obvious that the information to cover the 10 twelvemonth period was non available in the needed measure so. what could be got was used. The survey covers a period of 10 ( ten ) old ages crossing 1990 to 1999.