Making distributions to shareholders

Dividend policy

According to the traditional view:

      Dividend policy is important for shareholders.

      Shareholders prefer current dividends to future dividends as the latter are more uncertain.

      Shareholders are likely to discount the future dividends at a higher rate to account for greater uncertainty of future dividends.

      A generous dividend policy represents optimal dividend policy

      The level of dividend payout affects shareholder wealth.

According to the modernist view:

      The pattern of dividend payments adopted by a business has no effect on shareholder wealth.

      It is possible for individual shareholders to adjust the dividend policy of a business to meet his or her particular requirements.

      If a business does not pay a dividend, the shareholder can create home-made dividends by selling shares.

      If a business provides a dividend that the shareholder would not like to receive, the dividend received can be reinvested in additional shares.

      There is no optimal dividend policy and the dividend decision is irrelevant to shareholder wealth. 

 The importance of dividends

      Clientele effect: particular dividend policies adopted by businesses tend to attract different types of shareholders.

      Information signalling: managers may use dividend policy to signal new information relating to future prospects.

      Reduction of agency costs: shareholders may try to reduce the cash available for managers to spend by insisting that the surplus cash be distributed to them in the form of dividend. Also, shareholders may try to reduce their stake in the business through withdrawals in the form of dividends

Lintner ’s findings on managers include:

      Commitment to long-term dividend payout ratios

      Emphasis on variations in dividends rather than the absolute dividend

      Investors’ preferrence for a smooth increase in dividends

      Reluctance to increase dividends as a result of a short-term increase in profits

Alternatives to cash dividends

Scrip dividends:

      Issue of shares rather than the payment of cash to shareholders

      Number of shares issued to each shareholder in proportion to the number of shares held

Share repurchase:

      When a business buys its own shares and then cancels them

      Public companies are normally required to buy back shares from funds generated either from distributable profits or from the proceeds of a new shares issue