DIVIDEND POLICY:

THEORETICAL VIEW AND

FIRM VALUE
Prepared by:
NOR FARA SHAHITRAH BINTI KAMAL
2015549097

WHAT IS DIVIDEND?
Dividend have been define as income that are gain from
issuing share and;
dividend are based on company profit,
dividend will be distribute to their shareholder as a return for their
investment.

Ashare priceis thepriceof a singleshareof a number of

saleable stocks of a company, derivative or other financial
asset.
In layman's terms, thestock priceis the highest amount
someone is willing to pay for thestock, or the lowest amount
that it can be bought for.

Irrelevance
theory

Bird in Hand
Theory
Signaling
Hypothesis

Theoretical
View
Relevance
theory

Agency Costs
and Free Cash
Flow Hypothesis
Tax-Effect
Hypothesis

Dividend Irrelevance Theory

(Miller & Modigliani, 1961)

Whether dividend was being paid or not to shareholders, are

irrelevance with share prices.
The distribution of dividend does not affect share price
decrease
Miller & Modigliani make two assumptions;
perfect capital market
with perfectly rational investors

value of
firm is basically determined by the firms
the
They develop
MMaHypothesis
investment and financing decisions. Dividend decision has no
role in increasing or decreasing the value of the firm (Vidhya
& Mohanasundari, 2016) (p.62).

Bird in Hand Theory

In 1962, Myron Goldon and John Lintner developed the
bird in the hand theory.
They argue that dividend payout and the firms value
are related with each other
Evidence from (Vidhya & Mohanasundari, 2016)
They study about how NASDAQ firm which pay their cash
dividend regularly as their dividend policy and does it have
the relationship with firm value
Result;
agree that their dividend policy affect the share price which also

Signalling Hypothesis
(Ali & Chowdhury, 2010; Benartzi, Michaely, & Thaler, 1997)

The hypothesis highlight that there are asymmetric

information between managers and shareholders
To eliminate information gap between manager and investor,
(Vidhya & Mohanasundari, 2016) discuss that they are using dividend declaration
as a signal about firm performance in the future

The announcement regarding cash dividend can be signal

changes on manager expectation on the future prospect
especially when on imperfect market
Announcement on dividend will lead to shareholders
reaction

Agency Costs and Free Cash Flow Hypothesis

Manager and shareholder definitely have difference

interest where lead to agency cost with the conflict
among them.
By increasing dividend is one of the way to reduce
agency cost (Vidhya & Mohanasundari, 2016).
Following agency theory, (Sudipto Bhattacharya,
1979)
develop
Cash
Flow in
Signalling
Theory,
which
that
an increase
(decrease)
dividend will
lead to an
increase
also known as the cash flow hypothesis.
(decrease) in stock prices where the levels of cash dividends are associated
with the levels of permanent earnings which would affect the stock value
(Ali & Chowdhury, 2010)(p.53).

 Cash dividend payment and are related to

company operating cash flow
dividend only can be paid to shareholders if they
have positive or surplus in cash flow statement

If the firm announces their dividend payment

higher that market expectation, it will show
that the firm expected to have a better future
cash flow that will reflex the rise in share price.

Tax-Effect Hypothesis
The advantages of tax for capital gains motivate
investors to prefer firms that retain their
earnings rather than pay dividends.
As a result, a low level of dividends will raise the
stock price.
(Vidhya & Mohanasundari, 2016) mention that
tax-effect hypothesis prefer on low dividend
payout as tools to maximize shareholder value
because dividend are being taxed a higher rates as

DIVIDEND POLICY
Dividend policy is the set of guidelines a company uses to
decide how much of its earnings it will pay out to shareholders.
Dividend policy decisions are related to the utilization of profit
between dividend and retained earnings (I. Sharif, Ali, & Jan,
2015)
It are most important factors that affect share prices, and
share price is one of the tools to evaluate firm value.
Manager should adopt dividend policy which can maximize
shareholders wealth and also will increase share price and firm
value.

 Not all the firm can implement the same

dividend policy
the type of the business
managers decision which policy are the best
based on the firm resources
Company life cycle
Type of investor

Example of dividend policy

1. Dividend Per Share;
2. Dividend Payout Ratio;
3. Profit After Tax;
4. Earnings Per Share;
5. Return On Equity;
6. Price Earnings Ratio;
7. Retention Ratio.

Dividend Per Share;

The amount of dividend that have been declared by
firm for the every ordinary share.
show how much company gain profit in financial year
act as signalling to the investor about company ability to
earn profit in the future.

(Irfan & Economics, 2002; Okafor, Mgbame, &

Chijoke-Mgbame, 2011) found there are positive
relation with dividend per share with shareholder
price.

Dividend Payout Ratio;

Describe the amount of dividend that firm paid to
shareholder based on the amount of total net
income but the dividend was not paid and
distribute to shareholder but company decide to
hold on the dividend to be used for company
growth which called as retained earnings.
(Ponsian, Prosper, Yuda, & Samwel, 2015) conclude
that dividend policy that measured by dividend
payout ratio significantly affect share price.
if the firm shows a high dividend payout ratio, it can be

 (I. Sharif et al., 2015) concludes there are positive

relationship where an increasing in the amount of
dividend payout ratio also will increase the value of
share price and vice versa.
Risk averse investor who are reluctant to take high risk
would likely to invest in the firm because according to
dividend payout ratio,

WHY?
They have a secured dividend in the future as they hold the
amount dividend that should be paid to shareholders

Profit After Tax;

PAT= Gross Profit Operating expenses Interest
Taxes
have positive significant relationship with stock price
which have been explained as if the company achieve high
profit after tax, it will increase the share price (A. A. Khan
& Khan, 2011; K. I. Khan, 2012)
(Hunjra, Ijaz, Chani, Hassan, & Mustafa, 2014)
company net income are more accurate since they have deduct
all the expenses that may reduce the company income and may
also drop the share price.

Earnings Per Share;

Most preferred ratio because it act as a sign that firm

have ability to earn more profit (I. Sharif et al., 2015).
All public listed company need to show their earing per
share in the part of Statement of Financial Reporting
Required by IFRS and GAAP

Positive relationship which the amount of earning per

share can reflect the amount of share price in market
since it was a compulsory disclosure, public can get those
information easily and can make the decision whether to invest

Retention Ratio.
The proportion of earnings kept back in the business as retained
earnings.
Retention Ratio = (Net Income-Dividends)/Net Income
The retention ratio is 100% for companies that do not pay
dividends, and is zero for companies that pay out their entire net
income as dividends.
(K. I. Khan, 2012) found that there are negative relationship where
retention ratio does not give any influence on volatility of share
price.
The retention ratio is typically higher for growth companies that
are experiencing rapid increases in revenues and profits.

DIVIDEND POLICY AND FIRM VALUE

When the firm increasing dividend payments,
it increases a firms value.
but, most of the firm that pay high dividend
unable to sustain their dividend in the future
which can also drop the share price
These views are incarnated in three theories of
dividend policy:
high dividends increase the share price theory (bird-in thehand argument),
low dividends increase share price theory (argument of the

 Dividend policy may affect share price based

on their life cycle stages, nature of business
and economic factor
which can lead to the high fluctuations in market
price which give difficulties to investor to forecast
the price ranges and returns in the more accurate
method

The share that increase their dividend

payment, automatically their share price also
will be increase as the investor can predict

CONCLUSION
Dividend policy have the relevance relationship with firm value where
if the manager decide to choose the best dividend policy in the firm,
it may reflects on increasing or decline of share price which act as a
mirror of firm value.
The accounting professional bodies should enforce standards on
dividend policies of firm and ensure that it should be comply by the
firm and manager to given the fact that directors of companies are
responsible for making dividend decision.
Management also should be able to make sure that company have
stable increasing in their earning as well the cash flow and dividend
policy which are acceptable to all type of firm stakeholder (Ozuomba,
Anichebe, & Okoye, 2016).