The various types of Dividend policies used by companies

The versatile types of Dividend policies usanced by companiesDividend indemnity has drawn imput sufficient attention from miscellaneous researchers. One of the or so famous studies in this respect is Miller and Modigliani possibleness (1961), which asserted that the n angiotensin converting enzymes dividend form _or_ system of government is non important beca purpose it has no matter on the smart sets measure out, and as such it does non affect the ph 1 and solely(a)r owners riches. This is overdue to the fact that companies sweep up a Residual Dividend insurance insurance indemnity which is based on reinvestment of somatic lettuce in the on tap(predicate) investment opportunities (Van Horne 1983 Arn hoary 2008) with absolute(p) displace confront think of and diffusion the sur positivist exchange as a currency dividend to sh arh superannuateders.The above opening aroused a lot of rivalry on the part of researchers. However, the most important con t hat opposed it is that of Partington (1985) which claims that the companies do non fol get-go in practice the residual dividend approach as the dividend conclusions taken independently from the investment indemnity. Right now, controversies continue among researchers based on the subject without arriving at each decisive resultsThis chapter launch study the human race dividend indemnity to sh beholders, which is accounted to be one of the most important fiscal decisions, in view of its direct relationship to sh atomic number 18holders and financial support decisions and investment in the smart set. The chapter al low-toned for withal cover the alternatives to be addressed consisting of general dividend constitution and theories that associate the silver dividend indemnity with the companion grocery assess, and thitherfore the bon ton owners wealthiness in addition to the luck dividend insurance policy and buying buns policy, anyhow the specie dividend po licy and its relationship with the investment policy2-2 command Dividend PolicyThe Company Board suggests dish up dividend to shargonholders in an annual meeting (Watson and indicate 2004). The primary(prenominal) interest is to suggest acceptance and secure fair dividend for sh atomic number 18holders lucid with the enjoin of dividend decided by the participation management. at that placefore, in preparing dividend distribution, the mangers do non search scarcely for period year realize, but they, instead, get out look for the next earnings expect, and hence for the power of the union to maintain a steadfast rate of dividend victorious into consideration the systematic gain of this ratio. On their part, the investors be aware of this truth, and they look for a profit development in a positive vision expecting by dint ofout a stability of the time to come dividend. When the social club touchs senior game school kale for a particular year and do not expect the same level of profit for next years, they entrust make normal dividend and give additional dividend so as not to disappoint the investors hopes in the upcoming. The moolah are then divided into twain dividends, a normal and an incremental dividend, to make notification to investors that this type of dividend is unexpected and would not continue in the next (Levy and Sarnat 1994).There are several(prenominal)(prenominal) alternatives for the cyberspace dividend. The fraternity whitethorn either move on the benefit in the form of regular hard property dividends, or it whitethorn assign pelf in the form of shares dividends to shareholders. However, the above two types may be gived at the same time. Besides that, shareholders arsehole also obtain net profit when the gild tends to buyback its shares, and considers the regular cash dividend as something quite common (Broyles 2003).The lot of the profits black outd by the company is typic all(prenominal)y governed by several considerations. In addition to the law which prohibits the distribution of profits un little the company achieves a profit after deducting reserves, the engagements of the bonds, in depicted object the company ignores these bonds, often prevents companies from increase the similarity of cash dividend on a plastered level to secure the rights of bondholders (Watson and betoken 2004).Thus, the general dividend policy may well looked upon on the basis of oppositeiating among the cash dividends and the shares dividend through greatization of profits, or through buying back the companys shares. This is due to the fact that the investment policy is stock-still. The company impart hence detain profits to ante up expectant spending on produce and involution or debt re even offment, or extinguish the bonds if any, and distribute the remaining cash as a cash dividend, and also to finance any shortage in capital spending by issuing new shares or through outside borro wing. The company could detain the necessary silver to finance capital expenditure and re-buy part of the shares issued and distribute the remaining as a cash dividend.These alternatives entrust not affect the companys value, and in that locationfore the wealth of shareholders, if the company is operating in foodstuff characterized by ideal, efficiency and depth (Merton and Modigliani 1961 dull and Scholes 1974 Peter 1996). In case such characteristics are absent of the market, one seat expect arguments about the impingement of dividend policy, curiously cash, on the value of the company, and on that pointfore the wealth of shareholders. The second group (Gordon 1959 Blume 1980 Dyl and Weigand 1998 Koch and Shenoy 1999) hopes that increasing the ploughshare of cash dividends would increase the companys value, olibanum increasing the shareholders wealth, while the third group (Litzenberger and Ramaswamy 1979 Blume 1980 Litzenberger and Ramaswamy 1982 Ang and Peterson 1985 ) believes that increasing the voice of cash dividend get out elapse to a decline in the value of the company, on that pointby reducing the wealth of shareholders. These groups together with their theories will be discussed when dealing with the policy of cash dividend.The profits will be transferred to take back earnings account, which is used for purposes unflinching by the board and the approval of the General Assembly of the company. This account is ordinarily used to maintain a stable dividend step of cash dividends (a systematically dividend policy). During the years where the company mucklenot meet the heart of normal dividend, they will tend to the return earnings account to arrest any deficit. The General Assembly of the company has full authority to use this account for normal or abnormal cash dividend in upstanding or in part. It could also be used for company repurchase share, or for capitalization this account and distribution of share dividends to sharehold ers. On their part, shareholders can obtain their profits through a set of policies that can be unite in a single year, but it often takes one of the interest alternatives(Watson and Head 2004)A cash dividend policyShares dividend policy purchase back shares policy2-3 bullion Dividend PolicyThe impact of cash dividend policy on current prices of the company shares is considered to be very important, not only for policy makers, but also for investors, portfolio managers, and economists interested in the performance of capital markets (Watson and Head 2004). The questions to be raised here are Can managers increase the wealth of the owners of the company through a particular dividend policy? (Lumby and Jones 1999) be the companies with graduate(prenominal) dividend sold with premium? Should the shares of companies that retain their profits or distribute a percentage of its profits, be sold as well in a lesser price? The fact is that these questions were, and still are, the subjec ts of many an(prenominal) apply studies. Until now, there look intoms no consensus on the answers to these questions. The reason is the presence of another(prenominal) pertinent factors that affect the market value of the shares that enable us to measure the impact of dividend policy on profits alone. This means that researchers did not so cold prepare both proper and adequate tests and studies to distinguish in the midst of different hypotheses.The arguments among researchers about the dividend policy focus on that part of the cash dividend to be distributed to shareholders and its impact on the companys value and therefore the wealth of the owners of the company. Miller and Modigliani (1961) see that the cash dividend does not affect the value of the company, as the companys value will not be affected by how earned profits are divided but rather affected by the ability to achieve profits. Thus, there is no point in thinking of how to divide profits between dividends and ret urn earnings, while thinking must(prenominal) be tell towards maximizing these profits through the optimal investment policy as the way by which the cookie is divided will not cut to increase its size.In the opinion of others (see, Olson and McCann 1994 Lipson, Maquieira et al. 1998), the manner in which profits are divided between dividends and return earnings affects the companys value through an increase or decrease in the demand for the company shares, as the investors with risque incomes usually prefer companies without cash dividend if the value of taxes on cash dividend overhauls the taxes on capital gains, while investors typically prefer companies that cash high up dividends if they do not pay taxes or who were in low category of taxes. Also, investors in growing companies may not shoot the company to distribute high cash dividends and accept, instead, low cash dividends. This is because the internal return rate in these companies is usually greater than the bes of obtaining finances from sources other than return earnings, and thus maximise the wealth of shareholders through the detention of all or most of the profits and use them to finance projects which rush positive present value. Investors in non-growing companies, on their part, look for high dividends (see, Walter 1963). From the foregoing discussion, it is viewed by many scholars that the agreement between cash dividend policy with investor wishes will affect the market value, due to any increase or decrease for the company shares emanating from this harmony or compatibility, which will be invented on the price of its shares.The decision of cash dividend policy, particularly its cash portion, is one of the challenges facing company managers, because the distribution decision defines the silver to be given companys shareholders, and therefore the funds to remain for managers in the company to reinvest (Lumby and Jones 1999).The cash dividend policy can be considered as an action conception for the company to be followed when the company inevitably to make a decision regarding cash dividends, so that this plan could provide several options from which the company can choose to r all(prenominal) the desired goal. Such a plan is lay taking into account the following two main goals Maximizing the wealth of shareholders and meeting the company needs to finance its investments.There are several factors affecting the decision to choose the most appropriate alternative among the alternatives lendable in the action plan. These factors are legal, contractual, internal shareholders and market considerations. These factors pull down the available alternatives for the company in order to achieve its aims through a cash dividend policy practice. The available alternatives include the companys range of cash dividend policies the company could follow (Gitman 1997 Brigham and Houston 2004) . These includeFixed dividend policy rateon a regular basis dividend policyRegula rly low fixed dividend with superfluous or added dividendRemaining cash dividend policy.These policies will be discussed in detail as followsFixed Dividend Policy footstepThis percentage is determined by apportionment of dividends on profits earned. The percentage distribution of 80% of the net profits derived mean that the company will distribute 80% of its profits and reserves 20% of hold earnings. Since corporate annual profits are not fixed, adopting this policy will get out to a fluctuation in the amount of dividends because the stability of the dividends rate from non fixed profit leads to a difference in the amount of the annual dividends, which is the main criticisms of this policy. Since the fluctuation of the quantity of dividends is one of the benchmarks that measure the risks of the company and because the non fluctuation of the profits is usually seen as something positive for current and future performance of the company, the prices of company shares that follow su ch a policy may be adversely affected by this policy.Regular Dividend PolicyThe company, according to this policy, pays fixed rank as a dividend each year. For example, they may pay $0.2 per share each year, which will be fixed next years. This policy gives a positive indicator about the company because of the stability of the quantity of dividends, leading to reduce the risks of uncertainty. The companies that follow such a policy tend to increase the dividends rate whenever they feel that the increase in profits is steady and continuing in the future.Low regular fixed policy with special or added dividend rough companies follow a policy of systematic low dividend with additional dividends when the companys profits are unstable and highly volatile so that the companys profits are high in a given year but low in another, which makes it difficult for it to follow a regularly high-level profits distribution policy be able to maintain it. The company, therefore, seeks to pay low divid ends characterized by being consistent and continuous and then pay other additional and unusual dividends in the years where it can secure high profits. The company thus has been able to achieve consistency and continuity in the level of profitability, which are indicators of great importance on the part of investors, who consider this as something necessary for building confidence with the company.Remaining cash dividend policyThe optimal cash dividend rate for any company is best determined by the differentiation between a numbers of factors (Brigham, L. et al. 1999)Shareholders preference for cash dividend or capital gains.Investment opportunities available for the company.Optimal structure mixed bag for the companys capital (money sources).External financing costsThe last three factors combined affect the remaining dividend policy which is based on distributing cash dividends which exceeds the companys to finance all company investment opportunities that earn positive present value.The company should make the following three steps when applying the remaining cash dividends policy (Brigham and Houston 2004)Identifying all the available investment opportunities which realise positive present value and in which the company wishes to invest.Determining the optimal structure mix of capital that achieves the lowest cost.Using the profits to finance new projects with positive present value because of their low cost in comparison with new share issues in case they represent the best combination of capital.Based on this concept, and as long as the money needed by the company to reach the optimal mix of the capital structure is the equity funds , and not money borrowed, and as long as the need for funds exceeds the companys achieved profits and return earnings, the company will not make any dividends distribution for shareholders (Van Horne 1983). But in case the funds needed are less than the return earnings, the company will take its cash needs and distribute t he exceeded money as a cash dividend for shareholders.Besides that, if the optimal capital structure mix does not make it incumbent upon the company for financing or allowing to borrow without leading to the level of damage risks of the company, the company then may distribute profits to shareholders because of lack of need and also because these profits are considered as surplus (Arnold 2008).2-3-1 Factors affecting cash dividend policyA combination of factors affect the cash dividend policy and put stuff on the management when a dividends proposal is submitted to the General Assembly to be taken as a justification of reference for the Assembly when ratifying or adjusting this proposed. These most important of these factors are arguably (see, Damodaran 1997 Gitman 1997 Brigham, L. et al. 1999 Brigham and Houston 2004) the following legal, contractual, internal, growth and the expected expansion, shareholders preferences for cash dividend or capital gains and capital market conside rations. These factors are explained here in some detailsLegal restrictionsCash dividends should not exceed the total of retained earnings plus net profits for the current year. This is known as the Impairment of Capital Rule. If the companys net profits satisfactory to $500 thousand and it the retained earnings of $ 2 millions, then it should not distribute profits more than $ 2.5 million but if there is retained loss within equity amounting to $200 thousands, then it should not distribute more than $300 thousands.Contractual restrictionsUsually borrowing contracts restrict the amount of profits allowing the company to distribute to shareholders to ensure the rights of the lenders. When the company issues borrowing bonds, the contracts usually include both permissions and restrictions from the date of bonds topic till bonds date off. The bonds contract often will not allow the company to distribute cash dividends only if they exceed the amount earned in a certain amount. The cont ract might also prevent the company from increasing the percentage distribution of normal profits or may determine the profits that could be distributed by the companys net profits for distribution. The company accepts such conditions on themselves to reduce the risks of borrowing from the viewpoint of the lender, thus reducing borrowing costs. There are also restrictions on cash dividends imposed upon issuance of the preferent shares of the company. In this respect, it is natural to restrict the distribution of any dividends to ordinary shareholders unless they pay all preferable share profits.Internal constraintsThe companys ability to pay cash dividends is affected by the quantity of liquid funds available, not by profits and return earnings only. Although the company could resort to borrowing for financing the cash dividend or issuing new shares to finance the dividend process, the companies often do not do that because of high costs for this decision. The company can use it in urgent cases to stabilize the amount of dividends, since the fluctuation of the value of dividends may convey a cost that could be higher than the distribution finance costs. Thus, the companys ability for cash dividends or desire to distribution is often constrain by liquid funds available.Company expected growth and expansionThe volume of capital expenditure required for financing expansion and growth significantly affects cash dividend policy adopted by the company. If the company is in continuous expansion and development, using modern technology, they will need all the funds available to finance operations. On the other hand, the companies that cave in reached the format of maturity are more able to distribute cash dividends than companies in growth.Shareholders preference for cash dividends or capital gainsOne of the management functions is to maximise the company owners wealth therefore we should take into account the owners interests when preparing the cash dividend pol icy. The companys ability to distribute cash profits and desire to do so are often constrained by several important factors affecting the interests of company owners (Brigham, L. et al. 1999)Tax status of the companys ownersIf most of the companys owners are affluent are in high tax brackets, the company will resort to a dividends policy whereby it can reduce the impact of taxes on the shareholders profits.Investment opportunities available for company ownersIf shareholders can obtain returns for re-investing their profits exceeding the companys returns, the company must distribute a greater analogy of profits to enable shareholders to maximize their wealth by reinvesting these profits. But if the companys returns are more than shareholders returns, then the company must transfer the maximum part of their profit to return earnings for reinvestment in order to maximize the shareholders wealth.The steady control of former shareholdersIf the company tends to distribute all, or most, o f profits achieved over the years, it will find itself forced to issue new shares to finance the expansion and development projects. This would first lead to relieve and minimize the control of the companys former owners of the company and then the profits to be gained would be reduced because of the increasing number of company owners due to the issuance of new shares. This situation could be remedied through the allocation of shares, by allowing old shareholders to subscribe for new shares, each according to his/her contribution and giving them priority in this respect. The company could also resort to another alternative, i.e. to reduce the proportion of cash dividends if they want to retain full control over old shareholders and show no inclination towards increasing the number of shareholders.Stable and swooning dividend policyInvestors give special importance to the stable and clear dividends policy. Also, they give special importance for the continuity of these dividends bec ause they believe that the stability, increase, and continuity of dividends would surely lead to reduce risks from the standpoint of investors. Therefore, investors tend to discount returns of companies whose policies of distribution are characterized by stability, increase and continuity at a discount rate less than other companies. This means that they highly evaluate these companies in other words, they ask for a less rate of returns, thereby reducing the companys capital cost. cabbage information contentInvestors are interested in the informational content of the profits. finished these profits, they can read the management forecasts for company future profits. As the mangers have more precise information about the company investors, on their part, will give special attention to the informational content of the profits.2-3-2 Theoretical Framework for Dividend policy and its impact on market valueWe can clarify the speculative framework for the relationship between the dividend policies (cash, shares and repurchase) and market value of the company through the moot system was brought by M M in 1961. They suggested that there was no relationship between the dividend policy and market value. Many researchers have supported this surmisal, but also others have suspicion about it. The advocates researchers believe that companies should follow residuals dividend policy while the opponents researchers divided into two divisions, the first believes that there is a positive relationship between the dividend policy and the company market value, others said that this relationship is negative.The relationship between the dividend policy and the company market value is also affected by other dimensions which create a number of other theories, where we find that the uncertainty created a bird in the hand theory , the presence of taxes helped to find a Tax issuing Theory, either shareholders loyalty has created a Clientele Effect Theory, Management distort to send some information through the dividend policy covered by Signaling Effect Theory, while the separation of management and owners (shareholders) has created Agency cost Theory. Therefore, we can draw the theoretical framework for the study through the following formTheoretical Framework (figure 2-1)Share DividendPositive Relationship negatively charged RelationshipIrrelevantMarket ValueRelationshipDividend PolicyIrrelevant TheoryRelevantResidual Dividend PolicyBird in the come about TheoryTax Effect TheoryClientele Effect TheorySignaling Effect TheoryAgency Cost TheoryCash DividendShare Repurchasing2-3-2-1 Irrelevance PropositionThere is a belief among many finance and economics specialists that cash dividends policy is not important because it is not relevant and does not affect the owners wealth. The source of this belief is a study conducted by Miller and Modigliani (1961). This study concluded that the dividends policy has no way out on the companys value, so the managers will no t be able to maximize the owners wealth through a dividends policy.The irrelevancy proposal concept for dividends policy on the owners wealth stems from the fundamental idea that companies which distribute continuous high cash dividends to shareholders and secure a little bit higher share prices (Archer, Choate et al. 1983 Lumby and Jones 1999). As a result, the investors capital gains are very limited in this company as he would receive the same returns received by other investors holding another companys shares with low dividends while its prices become high because of the return earnings, and so he obtains high capital gains which compensates the limited cash dividends. In both cases, the shareholders wealth is the profits obtained by cash dividend plus capital gains realized from rising share prices. In case there are no taxes or whether taxes on capital gains are compeer, the investor will not be affected, whether the company has established cash dividends or unploughed the profit in return earnings and the investor has obtain capital gains when interchange his shares as a result of the rise of the companys shares by cash undistributed profits with no change in the other effective factors.This theory is based on the following assumptions (Merton and Modigliani 1961)There are no taxes, or the taxes rate on cash dividends and taxes rate on capital gains are equal.There is no traffics cost for the process of selling or buying shares so that, if the investor needs cash, he will be able to sell his shares without losing any commissions and fees instead of cash dividends.The investor is absolutely rational in his decisions.There are no agency costs. This means that the company managers that distribute low cash dividends do not use the company profits to achieve personal goals that may harm the company (Jensen 1986).The company operates chthonian a full and efficient market, which means that the information is available and fond to all at the same time wi thout any costs, and the stock prices reflect information and absolutely influenced by it at the moment provided.There is no information gap, including that the company operates under a full and efficient market. The future outlook on the performance of the company is homogeneous among all investors, as so do information and expectations among managers and investors.According to irrelevance proposal of marriage, the dividend policy affects only the level of external financing required to finance future projects with positive net present value. This means that each dollar distributed to shareholders represents a capital loss of a dollar. According to this hypothesis, the only constraint to the companys market value is the companys investment policy, not the companys dividends policy followed. This is because the investment policy is responsible for future profits (Miller and Modigliani 1961). Accordingly, the companys decision on the distribution of cash or non-profit distribution w ould not affect the market value of the company and therefore would not affect the owners wealth. This hypothesis recommends that managers should give greater importance to the investment policy and let the dividends policy follow the investment policy, which is known the Residual Dividend Approach.The advocates of the irrelevance proposition hypothesis (Black and Scholes 1974 Miller and Scholes 1978 Merton and Myron 1982 Merton 1986 Peter 1996) adopt the idea that the investor can build his own cash dividends policy regardless of the companys dividends policy. This is known as Homemade Dividend(Merton and Modigliani 1961) where the investors can obtain income through selling part of his shares equal to the value of cash profits that could have been distributed by the company, if the company does not have cash dividends and the investor himself wishes to receive cash dividends to meet his consumer needs. He may wish also to reinvest cash dividends distributed by the company in case the investor shows no desire for cash dividends. By following this method, the investor will not be affected by the companys dividends policy, and therefore would not be compelled to abdicate the stocks of companies followed by a dividends policy which is not consistent with his wishes.One of the criticisms against the irrelevance proposition hypothesis is that it cannot be practically acceptable. The theory of building a dividends policy for each investor based on efficient market, with no transaction costs for buying and selling (Dempsey and Laber 1992), is not practical. In addition, the investor will pay taxes on cash dividends or capital gains, making the adoption of a specific dividends policy for each investor something costly. Besides, the investment in companies whose cash dividends policy is consistent with the investors needs is less expensive than building a special dividends policy. The hypothesis has been built on the basis that the investor is quite rational when tak ing his decisions. The psychological tests have proved, however, that human beings are not rational one hundred percent with regard to decision-making. Shefrin and Statman (1984) in their study said that investors have an unreasonable preference regarding the profit dividends this is not consistent with the irrelevance proposition hypothesis. The irrelevance proposition hypothesis is also criticised for assuming equality between the cash dividends and capital gains, while cash dividend is a cash in hand without any uncertainty risk, and the capital gains is cash in the future with a lot of risks. So, how can they be equal?The irrelevance proposition hypothesis has been built on a set of assumptions and entropy that have already been indicated. It is understood here that any change in these assumptions and data would naturally lead to a change in the basic hypothesis and therefore to a change in the results. Accordingly, and in practical terms, the financial markets in general do no t agree with these assumptions.