"The harder we look at the dividend picture, the more it seems like a puzzle with pieces that just don't fit together" (Black, 1976) This research analysis is conducted into three stages. The emphasis is firstly on the dividend, secondly dividend policy and moving onto the theories of dividend implements into a new company of Luton Brickworks Plc. The first section will cover successfully the dividend and dividend policy, but the second part of my report is related about the theories and arguments of the directors Luton Brickworks plc company. In third part of my report, I would explain about the how a dividends payment affects the shareholders and conclusion. According to my research, Dividends are payments made to its shareholders by a Corporation, firm and company. It is paid out to its shareholders from the portion of the corporation's profit. When profit or surplus is achieved by a Corporation or firm that money can be used in two ways; payments to shareholders as dividends or re-invested in the business also known as retained earnings. Most of the Firms and Corporations hold back a percentage of their profits and pay the rest of the profits as Dividend (Arnold, 1998).
Considering the dividends there are always three dates for announcing it. First date is declaration date in which company announce the dividend payments. Second date in which companies list the all shareholders and in third date called ex-dividend date in which companies clear the all previous transactions. And in accumulation to this six types of dividend are considered that companies pay to its shareholders.
Cash Dividend - Payment of cash by the firm to its shareholders.
Ex-Dividend Date - Date that determines whether a stockholder is entitled to a dividend payment; anyone holding stock before this date is entitled to a dividend.
Record Date - Person who owns stock on this date received the dividend.
Stock Dividend - Distribution of additional shares to a firm's stockholders.
Stock Splits - Issue of additional shares to firm's stockholders.
Stock Repurchase - Firm buys back stock from its shareholders (Kennedy 2011).
Dividend policy:
Dividend Policy as the trade-off between retaining earnings on the one hand and paying out cash and issuing new shares on the others. And is nothing much but the policy a corporation uses to decide if they are going to pay the Dividend, if yes, then how much it will pay out to its shareholders (Richard et al, 1996). And according to my research, shareholder analyze the company capability that either company can initiate the dividends or not, dividend payment announced by the company generally after the earnings. Usually, companies pay the dividends regularly but companies also have option that they can call the dividend anytime, so because of this reason companies set a regulatory policy which is called dividend policy in which company set the rules and regulations about the dividend that how much, when and why they should pay the dividend to its share holder.
Theories Related to Dividend Policies-
Dividend Irrelevance Theory
According to Modigliani-Miller (1961) theorem, ''dividend-irrelevance theory" indicates that there is no effect on a Corporation's/Company's capital structure from dividend payout. With no taxes, agency costs, bankruptcy cost, asymmetric information, and in efficient market, dividend policy doesn't affect the value of the company and is completely irrelevant (Arnold, 1998).
For example, from an investor's point of view if the company's/corporation's dividend is too high, more than his expectations then he might buy new stock with that dividend. On the other hand, from the investor's point of view if the Company's/Corporation's dividend is too low, the investor could sell some of the company's stock to get some extra cash or to duplicate the cash flow as he expected. So according to investor's dividend is irrelevant to them. Investor's don't really care about the Company's/Corporation's dividend policy as they can simulate cash on their own.
Dividend relevance theory
Bird in the Hand Theory
In Comparison with the Modigliani-Miller theorem, ''dividend-irrelevance theory", The Bird - In - The - Hand Theory states that dividend payout is relevant to the investors and growth of the Company/Corporation. John Lintner and Myron Gordon took the equation that total return (k) is equal to dividend yield plus capital gains and assumed that (K) will increase as the Company's or Corporation's dividend or payout would increase.
According to Linter and Gordon (1963) investor's when making decisions related to stocks value dividends more than capital gains.
Bird - In - Hand - The - Theory might sound common as it is derived from an old saying "a bird in the hand is worth two in the bush", and if applied to this theory ''the bird in the hand'' is being referred to dividends and ''the bush'' is nothing but the capital gains.
Tax Preference Theory…
Investors are most importantly concerned about the taxes. As we all know that Dividends are taxed at a higher rate as compared to the capital gains. This is why investors may prefer capital gains over dividends. This theory is known as ''Tax Preference Theory"
Investors can wait until and unless the capital gain is not realized as capital gains are not paid until an investment is sold, but the investors can't wait for the dividend payment over which the Company or Corporation has complete control.
In the case for estate situations capital gains are not realized. For example, if an Investor XYZ has bought stock for an ABC Corporation and has kept the stock for more than 50 years, until his death, when the stock is passed on to his/her heir. That heir will not pay any taxes on that particular stock appreciation.
Analysis and Arguments
The Luton Brickworks PLC is a newly formed company which aims to maximize shareholder wealth and the company have three boards of directors. The board of directors of Luton Brickworks PLC is still deciding whether to declare dividend or not, if yes then what would be the dividend policy and dividend level.
Below is the argument of the three directors who are having different opinions in regards to the dividend policy for Luton Brickworks PLC.
Director A - Believes in high cash dividend payout as it would reflect positively on the market value of the Company's shares.
ARGUMENTS OF DIRECTOR-A
According to the situation of director "A", supporting to the relevance theory and announced that company should pay the dividends because its investor in order to raise the value of company shareholders wealth maximization. The Bird hand theory (1963) is supporting to the director "A" because the Luton Brickworks is newly company. He should pay the dividends because this is a good sign for investors. But in the other hand if company didn't pay the dividends he should pay the more tax on earning. There is another point about the market is imperfection because in that type of market the information to the shareholder is wrong and they don't know about the further plan in future. And when a company didn't pay the dividend and he purchase own shares in the Market. When he purchase the own share he should pay the transaction cost earning per share and this is not good for a company. And the end point, the company should pay the dividends because investor found more opportunity to invest in future NPV.
Consequently, according to my point of view, the Luton Brickworks is new company. He didn't pay the dividends because he has not too much funds for pay the dividends. If he has good profits then he invests to in new projects because it's good for NPV and properly establishes the company. And the company should save the retain earnings for the bad time period.
ARGUMENTS OF DIRECTO- B
Director B- Believes if company paid a cash dividend or not there is not affect on the shareholder wealth maximisation.
The director "B" announced if the company paid a cash dividend or not there is not such an impact on shareholder wealth maximization. According to the Modigliani and Miller "MM" (1961), "the irrelevancy theory" supports the director B arguments and also support the dividend policy is the irrelevant of the share market value. MM(1961) also support the perfect and certain market and said that there is no tax on profit and also have not transactions cost shares are sold in the market. In simple words, director B said that the market values of the shares are irrelevant within the market.
According to my research, when the market is perfect and the information are equally available to everyone in the market. If the firm decides the dividend rather than the new invest in the new project and the retain earnings are less for the new investment. The deficit of earning should make new sources and that deficit of retain earning is equal to the dividend payouts. At the end, results of the dividend payouts are indifferent from the retained earnings.
As (MM) has discuss in his theory that the market are perfect but in real word the market are imperfect. Share holders would like to get dividends instead of selling the shares for extra cash because in an imperfect market transaction cast are there. The shareholders would prefer to receive dividend payouts. As dividends is paid confidence level of investor's increases. Failure to maintain regular dividends payments can decrease investor confidence and thus woulde affect the valve of shares which in term reflects the valve of the company. Consequently, if the company invest the positive NPV projects
Argument-c
Director C has an opposite view of both directors if a company pay dividend and the `shareholder wealth is going to decrease. According to my research if a company pay the dividends. He has not further cash flow or liquidity for future investment in new projects. There is another affect, if the company pay the tax dividend and next year he didn't pay the dividends. This is not good for the company. The company should not pay the dividend because the Luton brickwork is new establishing company. Dividends are tax in a higher rate than capital gains the tax which means that share holder tax will decrease. If dividends are paid less money for the company for investments which means that if new finance is required they will have to issue new share which will cost the company issues in cost share.
Dividend policy is a positive sign for a company. It's creates a positive image of the company in the mind of investors as dividends are paid. Share price will increase and eventually the value of the company. Financing would be easier as the market value of the company is good. Maximizing signalling affect
Those companies have not profit can't pay the dividends because he should invest into new projects.
Investor aspects regular dividend payments so the management should consider the rate of dividend to be constant than the regularity of payment of dividends.
It is important to pay the dividends when the funds are released by the company.
Policy is control is another factor related to dividend payments. Directors would not like to add new shareholders as they want to have control on the company. So therefore they will declare low rate dividends than high rate. If the directors do not care about the policy of control then they follow the liberal dividend policy.
While deciding on the dividend policy the company should look at other rival companies and their rate of dividends on paid. As our company is new and has not dividend in the past.
Smaller firms finds it difficult to borrow money so they rely on internal sources and the retain earning they have.
Conclusion:
And the end of my result, a company should not cut a positive NPV project by paying dividends. Otherwise, dividends cannot be maintained. If the company reduce its dividend as this may involve there are cash flow problems. A company should try to pay dividends but there is still a problem because Luton Brickworks is new company at the same time he can't maintain sufficient retained earnings. The directors of a company want to meet together and make a decision first three to five years. We fully developed our company and then pay dividends. If the Luton Brickworks Plc Company achieved his targets and having enough earning in two to three years then he will pay the dividends because in Market Company share price goes up. A company must never allow the distribution of high dividend to be funded by borrowing money and worsening its debt-equity ratio. Finally, the company should set a target dividend payout ratio which is constructive but which also depends on the stability and prospects of the business.
Reference:
