Dividend Policy in Publicly Traded Companies Essay

Dividend Policy in Publicly Traded Companies - Essay Example For a firm with good future growth and investment opportunities, investors want the firm to put the earnings in other investment opportunities. Where as for a non growth company, investors would prefer present dividend income rather future capital gains which are uncertain. [2] Dividend policy of a firm will divide the earnings into two parts as Dividends and Retained Earnings. Dividends are paid to the investors as cash for their share of the assets of the company. Where as Retained Earnings are used to fund the long term growth of the company, which are used to generate future earnings. The percentage of Dividends distributed and Retained Earnings are determined by the Payout Ratio of the Dividend Policy. Higher the Payout ratio, higher the Dividends and lower the Payout Ratio imply lower the Dividends. Usually growth oriented firms have lower payout ratio and higher Retention Ratio. That means large amount of earnings are retained to increase future earnings. The investors of low dividend paid companies will get their returns through capital gains. The relation between growth and Payout Ratio can be best understood by Dividends on one hand increase cash earnings of the investors and reduce the share on the assets of the firm. In the case of high tax on the earnings of the dividends by the government investors are more interested in firm to keep the earnings for future growth of the earnings. Otherwise for a low growth oriented firm investors want cash dividends as they can earn more return else where. According to Miller and Modigliani in a perfect market condition and in a no tax situation investors are indifferent to a company that pays dividend and another not pays dividend. What ever the investors lose in the form dividends are gained through capital appreciation. The investors believe that the dividends are put to earn further gains in the future. On the expectation of increased future earnings the prices of the stock increase giving the investors capital investors which they can make by selling the stock at higher price. But stock market history shows us that dividends are really matter for any particular stock. Most of the non dividend paying companies are invariably loss making dogs[4] These companies does not have earnings capacity in their business and are struggling even to pay the dividends shareholders. Investors think the company has lost the earning capacity. The selling pressure decreases the prices of those non dividend company shares. This is quite opposite to what the dividend theory of stock market as well as what Miller-Modigliani postulated. "One look at the JSE highest dividend yield share reveals the problem: It is Northern Engineering Industries Africa whose 3 000% dividend yield places it way ahead of second placed SA Reit at 70%."[5] The above example explains that the highest dividend paying Northern Engineering Industries has a higher price than the SA Reit, in spite of both the companies operate in the same industry. Higher dividends attract more and more investor interest in the stock. Thus the price of the shares increases on the future dividends as well as capital gains. Based