Dividends are cash payments to the shareholders of a company. It is a share of company profits which are distributed to stockholders. Some corporate owned offer investors to replace a dividend by their stock. The individual investor can choose to accept or not that offer. When a corporate offers to replace a dividend by its stock, it is usually a larger, more stable business in a field with little growth or a slow, steady growth potential. And that money could be reinvested to gain profits within the company and distributed to stockholders who had benefit from investing in the company. When the company offers to pay dividends, they can build a dividend policy which may influence to shareholders in the financial market. This base on the conditions of the company in the present and the future and investors.
In their seminal work in 1961, Miller and Modigliani argued that, nothing that the company does in the way of paying or not paying a dividend has any effect upon the shareholders' wealth. Managers don't need to try to find the dividend policy, because the dividend policy doesn't exist.
This means shareholders' wealth is the same regardless of the decision of the company that offers dividend.
The Modigliani-Miller theorem forms the basis for modern thinking on capital structure. It gives a certain market price process without taxes, bankruptcy costs, agency costs, and information. In the maket, the value of a firm is not influenced by the finance of the company. Nothing happened if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Black [1996] gives the question again, "Why do corporations pay dividends?" In addition, he poses a second question, "Why do investors pay attention to dividends?". It is difficult to answer that questions, it is like as a puzzle without questions. After a long time since Black's paper, the puzzle about the dividend still exits.
In this problem, there are two arguments that firms should or not pay dividend .The first arguments are supplied to prove that firms should not pay dividend, and according to The Modigliani-Miller theorem, the dividend policy is irrelevant to the share value. Investors can create dividends and get profit from investing of themselves. Besides, they usually are paid interest monthly or quarterly from bonds. So investors don't concentrate to the dividend policy.
The next reason is that the company with no dividend payout is more favorable for investor because taxation on a dividend is higher than on capital gain. It is believed that reinvesting funds will make to increase not also the value of the company but also the value of the stock in the market.
The second arguments are given to prove that firms should pay dividends.Fristly, based on the bird-in-the-hand theory (Lintner, 1962; Gordon, 1963) is one of the important theories which concern to the dividend policy in a company and shareholders are risk averse and prefer to receive dividend payment than future capital gains. The former is actual cash and the latter is based on future dividend yet to be received. Gordon contended that the payment of current dividends resolves investor. This theory is absolutely different with the Modigliani-Miller theorem. Lintner and Gordon showed the mistake of MM theory about the influence of dividend policy on company's cost of capital. The authors argued that the results of payouts are lower, the costs of capital is higher, so investors would like dividend than capital gains which the company retain its earnings. In other words, in MM theory, risk will be increased for investors when the capital gains are higher; dividend ratio is the larger total return. So according to Gordon and Lintner's theory, the riskiness of the company is only influenced by its cash-flows from operating assets, especially when the most investors reinvest the dividend in the similar , in the same company.
Another reason which firms should pay dividends is the excess cash hypothesis. If company has excess cash to fund for positive NPV projects, the dividends should be paid out.
institutions run out of potential profitable investments in their area of expertise.
Dividend signaling theory: An unexpected change in the dividend is regarded as a sign of how the directors view the future earnings prospects of the firm. Generally, a rise in dividend payment is viewed as a positive signal, conveying positive information about the firm's future prospects resulting in the rise in share prices. Conversely, a reduction in dividend payment is viewed as a negative signal, resulting in a decrease in share price.
Clientele effects: Some shareholders prefer companies whose dividend policies match their desired consumption pattern. In other words, this is where the nature of a firm's dividend will attract a particular type of shareholders/investors.
Agency cost theory: It is argued that the payment of dividend can reduce agency costs between shareholders and management. The payment of dividend reduces the amount of retained earnings available for reinvestment and requires the use of more external equity funds to finance growth. Raising external equity funds in the capital markets subjects the company to the scrutiny of regulators and potential investors, thereby serving as a monitoring function of managerial performance.
Agency theory assumes that large-scale retention of earnings encourages behavior by managers that does not maximize shareholder value. Dividends, then, are a valuable financial tool for these firms because they help avoid asset/capital structures that give managers wide discretion to make value-reducing investments. The evidence presented in this paper uniformly and strongly supports this view of dividend policy.
In opposition to these two arguments is the idea that a high dividend payout is important for investors because dividends provide certainty about the company's financial well-being; dividends are also attractive for investors looking to secure current income. In addition, there are many examples of how the decrease and increase of a dividend distribution can affect the price of a security. Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions; these companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends. Furthermore, companies without a dividend history are generally viewed favorably when they declare new dividends
B) The reasons why firms repurchase their shares?
Share repurchase is an alternative way to return money, by buying backs the own issued shares on the open market. This makes to decrease the quantity of outstanding shares. This is usually a suggestion that the shares of a company are undervalued. Companies issue stock in order to obtain resources for the financing of particular projects. However, they have the right to buy them back when they decide to under specific conditions. This action is known as repurchase or also stock buyback. It represents the purchase of outstanding shares of company's stocks to the public and exceeds out of the company's control. In order to accomplish Share repurchase, the company can follow one of the following ways:
Firstly, the company can offer the repurchase of shares to existing shareholders by offering them a fixed price that is above the current market price. The number of shares to be repurchased is fixed as well as the time period within which the repurchase will take place. This way is called as tender offer.
The second way can be undertaken under the conditions of depressed stock prices. In this method, the company purchases its stocks directly from the open market. Again there is a time period within which the repurchase is executed.
There are two main factors to become the successful investor .That is the knowledge and the right trading platform. The truth is that share repurchases are nothing more than a cash dividend to shareholders. Share repurchase may be good for some shareholders. Beside, it may replace for unbeneficial financial ratios. So there are 4 reasons to explain why a company want to repurchase its stocks.
Reason 1: Base on signaling theory, the Company possesses a large sum of money and considers the stock buyback as a way of distributing it to its shareholders. Part of the money is distributed as dividends. Another way is by purchasing outstanding shares. The latter method is for the benefit of shareholders whenever they don't sell by the shares which is decreasing, they take advantage of this maneuver.
Reason 2:
Base on capital structure theory, the second reason is to temporarily increase the financial ratios of the company in the conditions of low ones. Since such ratios as EPS (earnings per share) and PE (price earnings) are depended on the quantity of outstanding shares, the decrease in the quantity of shares will lead to better numbers in these ratios.
Reason 3
The third reason for buybacks is to alleviate employee stock option programs. In this way shareholder value will be increased and at the same time dilution will be reduced.
Reason 4
Base on The Agency free cash flow theory, stock buybacks can be used as a method of protection against takeovers from other companies. Since the stock buyback includes the repurchase of stocks from the open market, the takeover of an unfriendly competitor is made more difficult. Having these reasons for executing stock buybacks, be aware of the exact reasons of your company when it announces the repurchase of stocks. If the price is right and this represents the most efficient use of money, then you will benefit from the stock buyback. However, if the intrinsic reasons of the company are the coverage of poor financial ratios or employee stock option plans, then be on the guard.
