Dividend Policy

Group No. 02

Babar Adeeb Sohail Rizwan Syed Faizan Haider

MM121037 PM123012 MM121054

Dividend
The portion of earnings which is distributed among the shareholders

Dividend policy
Determines the division of Earnings between payment to shareholders & retained earnings.

Do investors prefer high or low payouts? There are three theories:

Dividends are irrelevant: Investors dont care about

payout. Bird in the hand: Investors prefer a high payout. Tax preference: Investors prefer a low payout, hence growth.

Dividend Irrelevance Theory

Investors are indifferent between dividends and

retention-generated capital gains. If they want cash, they can sell stock. If they dont want cash, they can use dividends to buy stock.(Modigliani-Miller, 1961) Assumptions:
No difference between the tax on dividend and capital gain. No flotation and transaction cost. Free and equal access to the same information to all. No conflict of interest between the managers and security

holders. All participants in the market are price taker.

Proof of irrelevancy:
DDM

Rate of return

Multiply with number of share (n)

Proof of irrelevancy(cont.)
Sources and Uses of Fund

Putting the value of nD1 in V0 Equation

(n+m)P1=V1

Empirical Evidence
Black and Scholes (1974) tested the relationship of

dividend yield and stock return to identify the impact of dividend policy on stock prices. They analyzed 25 portfolios of common stocks listed on NYSE.

Their result showed that dividend yield coefficient (1)

is not significantly different from the zero in the entire period (1936-1966) or for any shorter period between this.

Bird-in-the-Hand Theory
Investors think dividends are less risky than potential

future capital gains, hence they like dividends. If so, investors would value high payout firms more highly. The higher dividends reduce the uncertainty and will result in decrease in cost of capital and hence increase the share price.

BIH Theory- Empirical Evidence

Three reasons of investment (Gordon, 1959)

To obtain dividend To get Earning (capital gain) To obtain dividend as well as earning.

Cross Sectional data (1951 & 1954), Chemical, Food, Steel

and Machine Tool.

Dividends have greater impact on the share prices than the

retained earning. Required rate of return on a share increases with the fraction of retained earning because of uncertainty associated with the future earning.

Tax Preference Theory

MM theory ignore the effect of the tax but in the real

world taxes exist. Retained earnings lead to long-term capital gains, which are taxed at lower rates than dividends. This could cause investors to prefer firms with low payouts. Dividends are also taxed immediately. Tax hypothesis suggest that low dividend payout ratios lower the cost of capital and increase the stock prices.

Possible Stock Price Effects

Stock Price (Rs)
40 30 Bird-in-Hand

Irrelevance

20
Tax preference 10

50%

100%

Payout

Possible Cost of Equity Effects

Cost of equity (%)
Tax Preference

20

15

Irrelevance

10

Bird-in-Hand

50%

100%

Payout

Rational Man Thinking

No consensus about the dividends.
Generally investor prefer to get dividend. Market responds positively to the increase in the

dividend. In Pakistan, there is so much uncertainty. Nominal investment for long term. Investors sell as prices increase, which mean they prefer to the capital gain.

Determinants of Dividend Payout Ratios: Evidence from United States

Dependent Variable: Dividend Payout (PAYOUT)
Independent Variables: Profit Margin, Sales Growth, Debt-To-

Equity Ratio, Tax, Cash, Market-to-Book Ratio.

Dividend payout ratio is the function of profit margin, sales

growth, debt-to-equity ratio, and tax. For Services industry the dividend payout ratio is the function of profit margin, sales growth, and debt-to-equity ratio. For manufacturing firms they find that dividend payout ratio is the function of profit margin, tax, and market-to-book ratio.

Determinants of Stock Price Volatility in Karachi Stock Exchange: Role of Corporate Dividend Policy
Dependent Variable: Price Volatility
Independent

Variables: Dividend Yield, Payout Leverage, Assets Growth, Earnings Volatility, Size.

Ratio,

The results found that dividend policy has a strong

significant relationship with the stock price volatility in KSE.

The Impact of Dividend Policy on Shareholders Wealth

Dependent Variable: Market Price per Share

Independent

Variables: Dividend per Share, Retained Earnings per Share, Lagged Price Earnings Ratio, and Lagged Market Price.

MPSit= a + b DPSit+ c REit+ eit MPSit= a + b DPSit+ c REit+ (PE)t-1 + eit MPSit= a + b DPSit+ c REit+ (MPS)it-1 + eit

There is a significant impact of dividend policy on shareholders

wealth in Organic Chemical Companies. Shareholders wealth is not influenced by dividend payout for Inorganic Chemical Companies.

Ownership Structure and Dividend Policy: Evidence from Malaysian Companies

Dependant Variable: Dividend payout ratio Independent Variables: Largest, Second, Second5% Control Variables: ROA, Size, Debt, Risk, Year-effects,

Industry-effects.

Companies make higher dividend payout as the shareholding of

the largest shareholder increase. The magnitude of dividend payout is also larger when there is a presence of the substantial second largest shareholder in the company.

Thank You