Most investors take part in a company's operation or management by purchasing shares of the firm. They concern about the operation of the enterprise, and they spend time on reading annual reports. The purpose of these activities is to get benefits from investment. The concrete "benefits" can be dividends. The distribution of firm's profit to shareholders is called dividend. In present market, there are four types of dividends, but only two are regarded as main dividends: they are cash dividend and share repurchases dividend. The cash dividend means that a company transfers wealth through cash to its shareholders, whereas the share repurchases dividend focuses on increasing the quantity of shares rather than cash. The repurchase dividends will be allocated to the investors or shareholders according to the quantity of shares they hold as the reward of their investment. However, after paying dividend to shareholders, the liquidity of firm will be reduced, and the company may lose a good opportunity for investing in a new project in the future; further, the book value will decrease as well. Although dividends payment has some negative effects on the firms, recent researches show that this kind of profit distributions is actually beneficial to companies' development. Not only enterprise owns positive net profits but also the firm which surfers from financial distress should pay dividends. This essay will discuss the reasons of firms distributing dividends, and the factors that influence the propensity of dividend payment.
For illustrating the main reasons of companies' paying dividends, we found several academic articles. The following fours are mainly used to support the explanation.
Article one: why individual investors want dividends
In this article, Dong et al. (2005) investigate the investors' preference through questionnaires and use graphs to analyze the results. They find out that most investors supported the dividends, and some choose dividend because of transaction costs. Furthermore, investors believe that receiving dividends is a useful method to communicate with the firms. According to Dong et al (2005) the research shows that investors have a strong desire to receive dividends. If the company cannot pay cash dividend to them, they prefer to receive the stock dividend than none. Most believe that pay dividends can enable investors to better understand the financial statement of the company, and then the investors can make decision on how to mix their investment portfolio best. However, the authors only have a small sample to do the research, so the result cannot represent everyone's ideas. For example, the authors cannot provide enough evidence for the irrational explanations of the existence dividend. All in all, the study has provided a better explanation on why companies pay dividends and why the investors want dividends, but there is a worry on the scale of sample that the study was based on.
Article two: Optimal dividend policy and growth option
Besides of the empirical analysis, the mathematical analysis also illustrates the incentive of paying dividend precisely. Décamps and Villeneuve (2005) publish an article about the correlation between distributing of dividends and retaining capital for the firm which is lack of liquidity. The authors begin the study with using mathematical formulation, assuming variables and setting up the benchmark. After that, by the theoretical calculation, the propositions and lemmas about the optimal option are presented. In the discussion part, the authors illustrate the relationship between current value of cash and future investment opportunity. According to Décamps and Villeneuve (2005), if the cash reserve's present value A is lower than the initial level B; companies will allocate dividends to shareholders. On the contrary, if the company can invest the capital into a project, and the profit is larger than present value A, the management may deduct the amount of dividend payout; or even pay no dividends so that more earnings can be made from investment. To use the dividend discount model can prove the accuracy of these opinions. The model can calculate the PV of the dividend, and by comparing the results of the discount calculation with the future profits' present value from investment, the reason for firms paying dividends is clear: to decrease the depreciation the value of cash flow.
Article three: Why do firms pay dividends? International evidence on the determinants of dividend policy
Traditionally speaking, companies pay dividends to investors is for satisfying them. However, Denis and Osobov (2008) argue that the possibility of paying dividend also relate to the companies' size, the capability of earning, the opportunity of development and the contribution of equity. The authors, firstly, illustrate the source of sample data used in their article; and then they analyze the essential factors which impact on the tendency of dividends payment. Thirdly, they use international data to represent the circumstance of dividend payment in six countries; after that the authors analyze the table data to show that most of the earning and dividends concentrated on few number of large corporation. Finally, the authors expressed their "considerable doubt the catering hypothesis as a first order explanation for the dividend payment" in the sample countries (Denis and Osobov 2008 P.80). Therefore, this article shows that to satisfy investors is not the only reason to pay dividends; other factors affect the distribution policy as well. For instance, the more profitability the company owns, the more cash flow can be provided for paying dividends. More specifically, if the company does not have a good opportunity to invest, it may increase the dividend and reduce the reserve (Denis and Osobov 2008). Therefore, firms pay dividend is not only for investors' preference, they also need to consider the mixed conditions. However, this article only research on the situation in mature market; whereas companies in the emerging market usually focus on development, which may not pay dividends at the beginning of the business life.
Article four: Why Do Financially Distressed Firms Increase (or Initiate) Dividends?
According to Zhou and Zhou (2009), those firms which suffered financial distress would change dividend plan to increase the amount of dividends, and the financial performance of these firms will become better after several years. In the article, the author and his colleagues illustrate that the future earning can rise if the management decided to increase dividends, even this company is under the condition of owing negative net income of at least 25% (in the short term or long term); and they provide graphs, calculations and observation. In the writers' opinion, the reason for firms to raise their dividends during the financial suffering period is that the increasing dividend decision will be supported by the earning in the future. On the other hand, mostly, investors are optimistic if they can see the profit and reward from their stocks go up in the market (Zhou and Zhou 2009). This article indicates that, firstly, the dividend payment is very crucial for companies; even those firms with negative profits. After the distribution of dividends, company may receive further capital from new or existed investors to reinvest. Secondly, for the shareholders, they have simple purpose: to gain benefits. The satisfaction from the dividends will increase their confidence to the company. Eventually, both of the outcomes will help the companies to develop in the future. This main proposition brings a new concept to dividends payment; moreover, it also provides another reason to explain why firms pay dividends. However, the article did not consider that the status of the firm or the condition of the economic environment will have impact on the dividend payment; for instance, the size of the firm, or the type of industry the firm is in, etc.
Overall, these four articles discuss the companies' motivation of distributing dividends by literature and mathematical analysis, they help us to comprehend why companies pay dividends.
Summary:
In conclusion, there are several essential factors can stimulate dividends distribution. Firms who own larger scale and better earning capability prefer paying dividends in order to satisfy their investors by transferring wealth via paying out dividend. The individual investors want to get dividends, at least repurchased share dividends (Dong et al., 2005). Also, the comparison between the PV of dividends and the expected return from future market will impact on the dividend policy (Décamps and Villeneuve 2005). Another interesting situation is that companies which have better financial performance tend to pay dividends because of the surplus of free cash flow. But financial distress firms also pay dividends for the development in the future (Zhou and Zhou 2009). Therefore, in most circumstance, companies will prefer to pay dividends to shareholders in order to increase the loyalty of investors and decrease the depreciation the value of cash flow.
