1.

Introduction

The goal of this assignment as a group in whole is to discuss what a dividend policy is, the factors
that affect it, its payment and other forms of dividends. We will also be putting into light the
residual policy, the relevance and irrelevance theory and the types of dividend policies.

2. Factors Affecting Dividend Policy

2.1. Legal Constraints or restrictions

The legal rules act as boundaries within which a company can declare dividends. In general,
cash dividends must be paid from current earnings or from past earnings that have been
retained by the corporations after providing for depreciation. However, a company may be
permitted to pay dividend in any financial year out of the profits of the company without
providing for depreciation.

2.2. Contractual Restraints

Companies sometimes may put restrictions on the dividend payments to protect their
interests, especially when the company is experiencing liquidity problems.

These constraints prohibit the payment of cash dividends until a certain level of earnings are
achieved.

2.3. Internal Constraints

The factors that can affect internal dividend of a company or corporations are:
1. Liquid Assets: The company must determine whether it has sufficient cash funds to
pay cash dividends
2. Growth Prospects: Refers to the companys expectation of growth in terms of assets
and capital investment.
 3. Financial Requirements: Financial requirements of a company are directly related to
its investment needs. The company should formulate its dividends policy on the basis
of its foreseeable investment needs
4. Availability of Funds: The dividend policy is also constrained by the availability of
funds and the need for additional investment. In evaluating its financial position, the
company should consider not only its ability to raise funds but also the cost involved
in it and the promptness with which financing can be obtained.
5. Earnings Stability: The stability of earnings also has a significant bearing on the
dividend decision of a company. Generally, the more stable the income stream, the
higher is the dividend Payout ratio.
6. Control Dividend Policy: May also be strongly influenced by the shareholders or the
managements control objectives. That is to say, sometimes management employs
dividend policy as an effective instrument to maintain its position of command and
control.

2.4. Owner Considerations

This is a restriction that demands the company to set up a policy that has a favourable effect
on the wealth of the majority of the owners.
Tax consideration
Owners investment opportunities
Potential dilution of ownership

2.5. Market Considerations

These calls for the directors awareness of the market possible response to certain types of
policies.

2.6. The Clientele Effect

Clientele are simply a group of investors who have the same preference.
The idea that the type of investors attracted to a particular kind of security will affect
the price of the security when policies or circumstances change.
The clientele effect refers to the fact that a company's dividend policy creates its own
client base. Specific dividend policies cater to specific needs of different clients, or
 investors. The value of a company's equity is affected by the different needs, demands
and objectives of different clients.
The influence of groups of investors attracted to companies with specific dividend
policies.

2.7. Signalling

Signalling is the idea that one agent sends some information about itself to another party
through an action. It took root in the idea of uneven information; in this case, managers know
more than investors, so investors will find "signals" in the managers' actions to get clues about
the company.

2.8. Agency Considerations

The payment of cash dividends can be regarded as shifting control of these assets from
managers to shareholders, the latter then having the option whether or not to allow
managers to regain operating control over such assets. This may constrain managers to
behave more in the interests of shareholder
The interests of shareholders, managers and creditors do not necessarily coincide.
Managers who are interested in their own careers, which may not necessarily involve
one company for more than a few years, are likely to favour short-term as opposed to
long-term growth. Creditors are interested in safeguarding their interest and original
loans.

3. Dividend Payment

3.1. Cash Dividend Payment

Cash dividends are paid periodically out of a company's operating profits to its shareholders.
Cash dividends may be categorized as regular or extra dividends. Regular dividends are an
annual feature and establish regular dividend-paying stock from the rest.
Extra dividends are paid in times of surplus earnings arising to a company. In times of
surplus revenue, a company may distribute some portion of it to its shareowners.

3.2. Dividend Reinvestment Plans (DRP)

 A program that permits investors to reinvest cash dividends automatically into the stock of
the issuing company.

Advantages to the investor:

Cost averaging of share purchases.
Opportunity (in some cases) to buy shares at a discount from market value.

Disadvantages to the investor:

Recordkeeping
Dividends are taxed when received, whether reinvested or not.

4. Other Forms of Dividends

Other forms of dividends other than cash are:

Stock dividends

A dividend paid in stock rather than in cash.

Companies may decide to distribute stock to shareholders of record if the company's
availability of liquid cash is in short supply.
Similar to cash dividends but instead of cash, a company pays out stock.
Also known as a bonus issue of shares.

Stock splits

A corporate action in which a company divides its existing shares into multiple
shares.
A stock split is usually done by companies that have seen their share price increase
to levels that are too high.

Stock repurchase

A repurchase of stock is a distribution in the form of the company buying back its stock from
shareholders.
 A program by which a company buys back its own shares from the marketplace,
reducing the number of outstanding shares.
Companies sometimes buy back their shares from the open market as a way to
increase shareholder value.

5. The Relevances of Dividend Policy

5.1. Residual Dividend Theory

Residual dividend refers to a method of calculating dividends.

A residual dividend policy is one where a company uses residual to fund dividend payments.
The residual dividend theory suggests that dividends must only be distributed after a firm
undertakes all acceptable investments.

5.2. Dividend Relevance Theory

The Gordon / Lintner Theory

Developed by Gordon (1963) and by Lintner (1962).

It states that dividends are relevant to determining of the value of the firm.
Shareholders prefer current dividends and that there is a direct relationship between a firm's
dividend policy and its market value.

5.3. Dividend Irrelevance Theory

A theory that investors are not concerned with a company's dividend policy since they can
always sell a percentage of their shares if they want to generate some amount of cash.

Modigiliani and Miller (M-M hypothesis) Theorem

The theory was developed by Modigliani & Miller known as the M and M theorem or
hypothesis.
 They claimed that neither the price of a firm's stock nor its cost of capital is affected by its
dividend policy.
In the absence of taxes or bankruptcy costs, dividend policy is also irrelevant. This is known
as the "dividend-irrelevance theory", indicating that there is no effect from dividends on a
company's capital structure or stock price.
So it makes no difference whether a firm finances itself with debt or equity.

In order to make their theory manageable MM had to make the following assumption:
Corporate income taxes do not exist.
There are no transaction costs.
Both managers and investors have access to the same information
Dividend policy has no impact on firm's capital budgeting

The above assumptions are not realistic in the real world. Both companies and investors have to pay
income taxes, flotation and transaction costs. Companys cost of equity might be affected by
dividend policy due to taxation and transaction costs.
Investors dont always have access to same information as managers. Therefore, it has to be said
that MM's conclusions concerning dividend irrelevance might prove to be wrong in the real world.

6. Types of Dividend Policies

A companys dividend must be formulated with two basic objectives in mind: providing for
sufficient financing and maximizing the wealth of the companys owners. There are three main
policies used:
Constant Dividend Payout Ratio: The company always pays a constant fraction of its
earnings as dividends. This is a dividend policy based on the payment of a certain
percentage of earnings to owners in each dividend period.
Regular Dividend Policy: Fixed-dollar dividend each period. This is a dividend policy based
on the payment of a fixed amount of a companys currency dividend on each period
regardless of the earnings.
Low-Regular-and-Extra Dividend Policy: This is a policy whereby the company pays a low
regular dividend, added by an additional dividend when earnings are higher than normal in a
given period.
7. Conclusion

Dividend policy is necessary to maximize company value. Dividend policy is needed as

unpredictable dividend policy would mean surprises to market participants which will result in
a drop in the companys stock price when there is a selling off. Thus, a well-planned dividend
policy could prevent these surprises and preserve or even enhance stock price.
8. References
Baker, H. Kent, (2009). Dividends and Dividend Policy: John Wiley & Sons
Da Silva, L.C., Goergen, M., & Renneboog, L., (2004). Dividend Policy and Corporate Governance:
Oxford University Press
Bhat, S., (2007). Financial Management: Principles and Practice 2nd Edition: Excel Books