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Introduction

The very presence and implications of asymmetric information in financial markets have
been a hot topic for extensive research. One of the major propositions of these papers have
been that dividend policy is related to asymmetric information1. In this project we will be
showing that there is relationship existing and provide direct evidence.
So before going into the topic let us just know what a dividend policy is.
Dividend policy is a method or technique or approach by the management of the firm towards
some constant payment to the shareholders out of the profits of the company. Dividend
decisions, may be for a short-term purpose, also called ad-hoc decisions or may be made for a
longer-term period.
A dividend policy should be made by the management with certain consideration in mind. It
should take into account the position of the firm and the economic environment and type of
industry in which it operates.2
If we look from the view point of value maximization, the share value heavily depends on the
amount of dividend distributed to the shareholders.
When a dividend policy is made then the policy should be able to answer certain questions.
Some of them are
1. How much dividend should a company distribute to its shareholders?
2. What will be the impact of the dividend policy on share price of the company?
3. What will happen if the amount of dividend Changes from year to year?
Also while the preparation of dividend policy there are certain determinants that shape the
dividend policy. They are
1. Dividend Pay-out Ratio
2. Stability of Dividend
3. Liquidity
4. Divisible Profit
5. Legal Constraints
6. Owner’s Consideration
7. Capital market conditions and inflation
Now as we have seen the objectives of dividend policy, let us see what the objective of
dividend policy is.

1
Khang, Kenneth and King, Dolly, Is Dividend Policy Related to Information Asymmetry: Evidence from
Insider Trading Gains (November 2002). AFA 2003 Washington, DC Meetings. Available at
SSRN: https://ssrn.com/abstract=342621 or http://dx.doi.org/10.2139/ssrn.342621
2
http://www.yourarticlelibrary.com/company/dividend-policy/dividend-policy-of-a-firm-meaning-and-
determinants/82545
Payment of dividend leads to increase in the price of shares on the one hand but leads to a
crunch in liquid resources for financing of prospective projects. There is an inverse
relationship between dividend payment and retained earnings.3
The main objectives of a dividend policy are:
1. Wealth maximization
2. Future prospects
3. Stable rate of dividend
4. Degree of control
Now we have known what a dividend policy is and what its determinants are, let us look
what is Asymmetric information and how it effects Dividend Policy.
Asymmetric information represents a problem when one party does not possess sufficient
information to other parties participating in the transaction, in order to obtain a correct
decision - constitutes an important aspect of financial markets4
Now as per the pecking order theory, Asymmetric information problems exacerbate the
magnitude of price decrease associated with new capital issues. So now the firms may not be
ready to issue equity when their stock is undervalued and also may forgo their positive NPV
investments. This under-pricing results from the asymmetric information in the market. The
relation between asymmetric information and dividends subsumes the argument that
asymmetric information problems adversely affect the issue costs, which can be controlled by
paying lower dividend. This shows that how asymmetric information in the market can lead
to companies changing their dividend policy to counter the aftereffects of the asymmetric
information.
Now there is second side of this coin, which says that dividends reduce asymmetric
information by acting as a signalling mechanism. This will be discussed in detail in latter half
of the report.

3
http://www.yourarticlelibrary.com/financial-management/dividend-decisions/determinants-and-objectives-
of-dividend-policy/44169
4
Govori, Fadil, 2011. "Ndikimi i informacionit asimetrik në tregjet financiare
[The Impact of Asymmetric Information in Financial Markets]," MPRA Paper 33831, University Library of
Munich, Germany.

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