DIVIDEND POLICY

Dividend Policy

Table of Content

Introduction3

Dividend Policy3

Importance of Dividend Policy3

Risks Related to Dividend Policy5

Conclusion6

References7

Dividend Policy

Introduction

Dividend is a portion of the current profit or retained earnings of a company paid to stockholders, by the instructions of the board of directors. Dividends are usually paid as cash but a company may choose to disburse dividends in the form of stocks.

Dividend gives a quick view of the firm's financial health. More than income generation dividends allow an investor to evaluate a company for investment prospect.

Dividend Policy

With the creation of joint stock companies dividend policy became a major issue in financial studies. Since the primary objective of the management is wealth maximization of shareholders; this objective can be achieved by distributing a fair share of income over their investment.

Importance of Dividend Policy

These days dividend policy has gained more attention from both academics and practitioners and has became an important issue because dividend policy determines whether disburse the profits among shareholders or retained earnings for self finance (Li et al., 2006).

To distribute the earnings a firm has to adopt a dividend policy. Several studies have been conducted to find out what dividend policy a company must adopt and follow but even after years of studies dividend policy is still a controversial issue, specially the relation between dividend policy and stock price (Allen and Rachim, 1996). Stock price is influenced by paying huge dividends (Gordon, 1963) large dividends are proxy for the future earnings (Baskin 1989).

Company's current projects and its future investment opportunities give a view of a company's financial health. Its dividend policy either independently or in combination with other elements, such as capital expenditure announcements, communicates the information about its financial health in the market.

For a company the dividend policy is very important because it affects both cash flows and cost of the operating cycle. According to Jensen and Mecking, 1976, payments of dividends influence managers to payout cash instead of investing it in inefficient projects or less than the cost of capital, in this way dividend payments decrease cost and increase cash flows (Rozeff, 1982 and Easterbrook, 1984).

Dividend declaration policy has a greater and long lasting influence over the investors of the company. For expansion and investment opportunity dividend policy may provide a proxy for growth. Dividend declaration gives the missing information about the firm it allows the market to estimate the profits of a firm. When profit are accompanied by dividend announcements investors ...