CHAPTER 8

DIVIDEND POLICY
WHAT IS DIVIDEND
Dividends are payments made to
stockholders from a firm's earnings, whether
those earnings were generated in the current
period or in previous periods
DIVIDEND POLICY
refers to the policy chalked out by companies
regarding the amount it would pay to their
shareholders as dividend. With profit making comes
the question of utilizing the profit gainfully.
The companies have two options with them:
(a) They can retain these profits within the
company
(b) They can pay these profits in the form of
dividends to their shareholders

Dividend policy of a firm, thus affects both the long term
financing and the wealth of shareholders.
Dividend policy is extremely important because of its
announcement effect on share values.
A stable dividend policy is expected to lead to higher
share prices because of the greater confidence of
investors about future prospects of the company
FORMS OF DIVIDEND
Cash Dividend
Cash dividend is by far the most important form of
dividend because it involves cash payment to
shareholders.
A firm BODs decides whether and in what amount to pay
cash dividends.
If the firm has already established a precedent of paying
dividends, the decision facing the Board is usually
whether to maintain or increase the dividend, and that
decision is based primarily on the firms recent
performance and its ability to generate cash flow in the
future.
Stock Dividend
Stock dividend is the payment to existing owners of a
dividend in the form of stock.
In a stock dividend, investors simply receive additional
shares in proportion to the shares they already own.
With a stock dividend, a firm does not pay out any cash
to shareholders.
As a result, the total market value of the firms assets and
liabilities, and therefore of its equity, is unchanged.
Stock Splits
A stock split is a method commonly used to lower the
market price of a firms stock by increasing the number of
shares belonging to each shareholder and is usually non-
taxable.
For example, in a 2-for-1 spilt, two new shares are
exchanged for each old share, with each new share
being worth half the value of each old share.
Share Repurchases
An alternative way to pay cash to investors is through a
share repurchase or buyback. In this kind of transaction,
the firm uses cash to buy shares of its own outstanding
stock from the market or directly from the shareholders
DIVIDEND POLICY THEORY
Irrelevance Theory
Modigliani and Miller researched and produced a
paper stating that dividends were irrelevant to share
value. They were of the view that the determinants
of value of a share are the availability of projects
with positive NPVs rather than pattern of dividends
paid out by a company to its shareholders
According to them under ideal conditions, the value
of the firm is unaffected by dividend policy

Bird-in-hand theory
This theory states that dividends are more predictable
than capital gains because managers can stabilize
dividends, but cannot control stock price.
Therefore, dividend payments are safe cash in hand
while the alternative capital gains are at best cash in the
bush
Tax Preference Theory
The theory argued taxes are paid on dividends in the
year they are received while taxes on capital gains do not
have to be paid until the stock is sold. Again taxes on
capital gains may be less than on dividends, which are
considered ordinary income. Thus depending on the tax
situation of the investor, investors will prefer that
companies retain the earnings and promote capital
appreciation

The Clientele effect Theory
The theory that a company's stock price will
move according to the demands and goals of
investors in reaction to a tax, dividend or other
policy change affecting the company.
The clientele effect assumes that investors are
attracted to different company policies, and that
when a company's policy changes, investors will
adjust their stock holdings accordingly. As a
result of this adjustment, the stock price will
move



IMPORTANT DIVIDEND PAYMENT DATES

Declaration date: The date on which a firms
directors announces to the shareholders and the
market that the company will pay a dividend.
Date of Record: The date on which investors must
own shares in order to receive the dividend
payment. Only shareholders listed as holders of
record are entitled to the upcoming dividend
payment.
Ex Dividend Date: The day on or after which all
shares bought and sold are no longer entitled to be
paid the most recently announced dividend
Distribution Date: The day on which a dividend is
paid (payment date) to shareholders. It is usually
two or more weeks before shareholders who owned
shares on the date of record receive their
dividends.